Large Banks Face Higher Risk From Commercial Property Loans, Sparking Increased Concern

The commercial real estate loan portfolios of the nation’s biggest banks are facing increased risk, new federal data shows, with an estimated $1.6 trillion in property financing expected to mature over the next two years.

More than 65 of the largest U.S. banks are at higher risk of failure because of their commercial property loan exposure, according to Florida Atlantic University analysis of the first-quarter data.

The 67 banks with more than $10 billion in assets have exposure to commercial real estate greater than 300% of their total equity based on data reported to regulators, the analysis found. Any ratio over 300% is viewed by the Federal Reserve as excessive exposure and could put the banks at greater risk of failure.

For comparison, the first-quarter industry average for commercial real estate loan exposure was 139% of total equity, the study found. The far higher exposure from the big banks is sparking concern because it comes at a time of increased interest rates to fight what’s proving to be persistent inflation and some lower demand, analysts and regulators say.

“This is a very serious development for our banking system as commercial real estate loans are repricing in a high interest-rate environment,” Rebel Cole, the Lynn Eminent Scholar chaired professor of finance at Florida Atlantic’s College of Business, said in a statement. “With commercial properties selling at serious discounts in the current market, banks eventually are going to be forced by regulators to write down those exposures.”

Cole’s words echo similar recent sentiments expressed by federal banking regulators.

“Supervisors and banks must remain vigilant and ready for expected and unexpected stresses, and presently there are several risks we are monitoring,” Federal Reserve Vice Chair for Supervision Michael Barr told Congress last week in a hearing. “For example, delinquency rates are rising among certain commercial real estate loans, such as those backed by offices.”

The total amount of commercial real estate loans past due or in nonaccrual status stood at $35 billion at the end of the first quarter, according to data from the Federal Deposit Insurance Corp. The total grew 9% from the previous quarter and was 59% higher than a year earlier — and the highest in 11 years.

While the problem is growing, the effects are still limited: The amount of troubled loans was just 1.23% of all outstanding commercial real estate lending.

Even so, that was still more than double what it was a year and a half ago.

The increasing trend in commercial real estate loan delinquencies was distinctly more pronounced among the largest banks, a group that reported a past due and nonaccrual rate of 4.48%. That is well above their pre-pandemic average rate of 0.59%.

The next tier of banks, those with between $10 billion and $250 billion in assets, is also showing rising stress in nonowner-occupied property loans. Their past due and nonaccrual rate was 1.47% in the first quarter, up from 1.35% in the fourth quarter and above the pre-pandemic rate of 0.66%.

Still, none of the 67 largest banks with ratios higher than 300% of equity examined by Florida Atlantic reported material amounts of nonperforming loans, Cole told CoStar News in an email.

From the viewpoint of the banks, the 300% ratio is more of a criteria than a limit, noted Jamie Woodwell, vice president and head of commercial real estate research at the Mortgage Bankers Association, in an email to CoStar News.

“The most important factor in [commercial real estate] right now is its diversity. Every loan and property is in a unique position, dependent on that particular property’s type and subtype, market and submarket, age and amenities, as well as its owner-type, lender-type, deal vintage and more. Broad brushstrokes definitely do not apply,” Woodwell said.

“On the lender side, most capital providers we speak with are eager to make loans at terms that make sense in today’s market,” he added. “That’s a key reason we’ve seen many capital sources increase their lending activity and just about every capital source increase their holdings of commercial mortgages. It’s the demand for mortgages they are hoping will pick up.”

The growing concern for Cole is what happens when the outstanding loans start coming due. The risk of being unable to refinance could drive nonperforming amounts higher.

That is a concern for the Fed as well.

“The rising trend in delinquencies, coupled with softening collateral values, could weaken CRE loan portfolios, particularly from loans coming due during this period of higher interest rates,” the U.S. central bank noted in its 2024 risk review released last week. “Borrowers could face difficulties refinancing CRE properties due to higher borrowing costs, which affect repayment capacity, and lower collateral values, two essential components considered by lenders.”

More than half the $1.6 trillion in commercial real estate debt coming due is held by banks and predominantly made up of loans financing nonfarm nonresidential properties including office buildings, according to the Fed. Large office loans — over $100 million — had the lowest refinance success rate among commercial real estate loans in 2023, possibly reflecting weak office conditions in big cities — a trend likely to continue in 2024, the Fed said.

Banks with less than $10 billion in total assets face similar risks because of their commercial real estate exposure, according to Cole. Among banks of any size, 1,871 have total commercial real estate exposure greater than 300%; 1,112 have exposure exceeding 400%; 551 have exposure exceeding 500%; and 243 have exposure in excess of 600%.

“Three banks have failed in the past year and now we have several candidates where their exposure to commercial real estate is over 500%,” Cole said in the statement. “Should another bank fail, it’s likely that depositors will pull their money out of these highly exposed banks, which could lead to a banking panic similar to what we saw during spring 2023.”