The Commercial Real Estate Market Facing Serious Headwinds
Over the past year, we, along with many other industry analysts, have identified Commercial Real Estate (CRE) concentration as a major area of risk. Rising interest rates and continued remote work arrangements have created higher vacancy rates and lower profit margins in both the apartment and office sectors. And, while 2023 was a difficult year for commercial real estate with office vacancy rates hitting almost 20%, 2024 looks even more problematic. Valuations on average have declined close to 20% already and are projected to decline another 10% this year. Additionally, a full 20%, or almost $1 trillion of the current $5 trillion CRE loan market, are maturing in 2024. This witches brew of high vacancy rates, lower appraised value, and continuing higher interest rates will put considerable pressure on landlords and lenders to both obtain financing and service these loans. Interest rate reductions by the Fed could help, but it is doubtful that they can lower rates far enough and fast enough to make a significant difference and counter the underlying market forces.
Is NYCB the Canary in the Coal Mine for Regional Banks?
While significant write-offs and losses have not yet occurred, a few banks with very high exposure have come under pressure. Most notable was New York Community Bank (NYCB), which reported a surprise loss for the 4th quarter, driven primarily by additional reserves in the CRE portfolio. We had identified NYCB as a highly risky and overvalued stock earlier in 2023, with the only thing supporting valuation was its dividend and high yield. When that dividend was slashed to next to nothing, the stock did the predictable thing and cratered. Most of the banks with significant CRE exposure are in the Regional sector with an average concentration of 35%, vs the Super Regional and Super Community averages of 13% and 28%, respectively. The reason for this large disparity in concentration mix is due to the stricter capital requirements placed on larger banks after the financial crisis in 2008. As those capital regulations were imposed, many larger banks reduced their CRE exposure, leaving the market open for Regional and Super Community banks who were looking to increase their loan portfolios in light of low loan demand in other categories such as Commercial and Industrial (C&I) lending. And rush in they did, fighting for every deal with low interest rates and incentives that fueled growth but burdened the balance sheet with considerable riski.The charts below show the percentage of CRE loans (Commercial Real Estate plus Multi-Family) for each of the banks we cover. These represent the most current data available.
When is a CRE loan, not a CRE loan?
It is important to understand that all CRE lending is not created equal. For example, NYCB was/is highly concentrated in loans to rent stabilized apartments in New York City. As interest rates increased and revenue increases were limited, delinquencies accelerated. That is not the case for all banks with large CRE portfolios, many of which remain high quality and do not represent significant risk. However, we do expect banks with large CRE concentrations to experience market, and perhaps regulatory, pressure over the remainder of the year. In addition to New York Community, banks that may have to provide more detail on the composition of their portfolios and assurances to analysts and investors include Atlantic Union (AUB), Synovus (SNV), Columbia (COLB), Pinnacle (PNFP), and Webster (WBS). We are not terribly concerned about the large CRE concentration of M&T (MTB) relative to its peers since over the years it has shown it has a superior risk management history and culture. Although we do not give investment advice on individual companies, we would encourage investors to monitor these banks and others for further signs of increasing CRE risk and deteriorating credit quality.
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