The Fed report highlights the risk of banks’ exposure to commercial real estate
Commercial real estate (CRE) poses a risk to U.S. banks, especially smaller regional lenders that are most exposed to the sector, according to the Federal Reserve in its latest financial stability report.
Of the 60% of CRE loans held by banks, more than two-thirds of them are held by lenders with less than $100 billion in assets, as defined by the Fed. Together, they have non-agricultural, non-residential CRE loan portfolios totaling $1.55 trillion, of which $500 billion is invested in downtown office and commercial real estate.
Loan losses for CRE will depend on the borrower’s degree of leverage, as property owners with high equity cushions are less likely to default, according to the report. Additionally, banks that issue loans with higher loan-to-value (LTV) ratios are more likely to experience financial distress because these loans are more difficult to refinance or modify. When real estate prices fall, as they have in recent months, LTV ratios rise.
Among regional banks, exposure to commercial real estate as a percentage of total loans ranged from 15.8% at KeyCorp ( KEY ) to 40.2% at Pasadena, Calif.-based East West Bancorp ( EWBC ). The share of loans invested in commercial real estate generally held steady among most mid-sized lenders, with PacWest Bancorp ( PACW ) seeing a significant decline in exposure. In PacWest, CRE loans as a share of total loans fell to 20% in the first quarter, down from 33% in the same quarter last year.
Commercial real estate includes offices, hospitals, retail space, industrial space and multi-family units. Although many economists have warned about commercial real estate, most of the worst problems have been confined to office properties, which make up 24.2 percent of the $10 trillion CRE market.
“Among the CRE categories, only offices – especially those in big cities – are struggling right now due to the rise of telecommuting, along with some retail establishments such as restaurants that depend on office workers,” said Joseph Wang, CIO at MonetaryMacro. com.
Office property loans are disproportionately made by the smallest lenders, which have greater exposure to the sector than large banks and mid-sized regional lenders.
“The smallest banks — the ones that few people have heard of — tend to be the most exposed to commercial real estate and have the most risk,” Wang said. “I don’t believe this crisis is systemic because the big banks and even most regional lenders have little exposure,” Wang added.