Major US Banks Struggle with Commercial Real Estate Loans and Higher Interest Rates

Large banks are currently facing significant challenges with their commercial real estate loans. Initially believed to be a problem for smaller banks, it's now evident that bigger banks are also experiencing considerable difficulties. This situation is compounded by rising interest rates and declining property values, which are affecting the financial stability of these institutions. While the stock market hasn't fully reflected these issues, the reality is that large banks are dealing with higher delinquency rates and nonaccrual loans, particularly for properties intended for leasing. This summary explores the various factors contributing to these financial struggles and their broader impact on the banking sector.

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Stock Market vs. Reality

The stock market hasn't fully reflected the challenges big banks are facing. While declining values of offices and commercial properties have hurt bank shares, smaller banks have been hit harder. The KBW Regional Banking Index is down about 12% this year, whereas the KBW Nasdaq Bank Index, which tracks larger lenders, has risen nearly 9%. Smaller banks hold more than a quarter of commercial real estate and multifamily property debt in the U.S., more than double the share of the top 25 largest banks, according to Moody’s. However, not all commercial real estate (CRE) loans are alike.

Different Types of CRE Loans

CRE loans can vary greatly. They can be for new construction or existing buildings, and the borrower might be the main tenant or plan to lease the property. The property could be an office tower, a medical facility, a strip mall, or a warehouse. Loans also differ in size and whether they are shared among banks or held by one bank.

Loan Performance

Data from S&P Global Market Intelligence for the first quarter shows a big difference in the percentage of delinquent or nonaccrual loans. Large banks with over $100 billion in assets had more than 4.4% of their CRE loans for third-party leasing marked as delinquent or nonaccrual, an increase from the previous quarter. Smaller banks had delinquency rates below 1%.

Impact of Interest Rates

Higher interest rates are a key factor. Owner-occupied CRE loans tend to perform well if the business is healthy and can make payments. However, properties for lease are more affected by interest rates. If the property’s income isn't enough to cover loan payments or refinancing costs, the loan can become problematic.

Geographical and Maturity Differences

Geography, such as city versus suburban lending, might also play a role. Larger banks might have more loans maturing soon. MSCI Real Assets reported that national banks held 29% of the office debt maturing last year and 20% this year, while regional and local banks held 16% last year and 13% this year.

Loan Structure and Provisions

CRE loans often have large payments due at the end of their terms. Banks with upcoming payoff dates are closely examining these loans. Many larger banks have already set aside substantial reserves for expected office-loan losses. The median first-quarter reserve ratio for office loans at banks tracked by Morgan Stanley was 8%, compared to the sub-2% loss allowance ratio across all insured banks and loan categories, per Federal Deposit Insurance Corp. data.

Charge-Off Rates and Future Risks

The net charge-off rate for non-owner-occupied CRE lending at large banks was over 1.1% in the first quarter, higher than at smaller banks, though this rate had decreased from the previous quarter. Today’s issues stem from past risks, raising questions about future risks. A property downturn affecting smaller or suburban properties could surprise smaller banks. Conversely, a stable economy with higher interest rates could benefit smaller banks, revealing value behind current concerns.

Also Read: Mortgage Rates Spike Above 7%, Slowing Home Financing and Market Momentum