Maturing commercial real estate debt could become the next big concern for smaller banks, and lenders' exposure to this corner of the credit market is sure to draw attention during the earnings season that gets underway next week.
At issue: Community and regional banks hold more than $2 trillion in CRE debt, according to Trepp Inc. The data firm estimated that $270 billion of the commercial mortgages held by banks are scheduled to mature this year, a record level.
After the March failures of Silicon Valley Bank and Signature Bank — and Silvergate Bank's demise through liquidation — analysts and investors are increasingly
"I don't think anyone is going to honestly tell you that the failures didn't magnify worry about recession and credit quality," said Piper Sandler analyst Stephen Scouten.
High interest rates already are hurting property owners who financed real estate purchases with floating-rate loans. Following multiple Federal Reserve
As billions more in fixed-rate commercial mortgages mature this year, property owners who need to refinance their debt will feel the pinch of high rates, too. Not only are CRE debt levels high, but analysts say key property types are under heavy pressure because of changes caused by the pandemic. Broad shifts to remote work, particularly in major cities with high costs, depleted demand for office space.
The U.S. office vacancy rate increased to 17% early this year from about 12% at the start of 2022, according to data provider IBISWorld. That matched the rate from the 2008 financial crisis and was up from less than 10% at the start of 2020, prior to the pandemic.
By extension, high-rise apartment buildings and retail properties that were designed for people to live and shop near their workplaces are also starting to get squeezed.
The bottom line is that more property owners struggling with the one-two punch of higher borrowing costs and increased vacancies could default on their loans. This could drive up banks' loan charge-offs and curb profits.
All of this also lowers the value of office and apartment skyscrapers, making it harder for owners to refinance debt on such properties. This compounds the challenges, observers say.
"There's bound to be more problems ahead," said Mike Matousek, head trader at U.S. Global Investors. "How much is dependent in part on whether or not we head into a recession — we just don't know yet on that — and whether banks face more fallout from these failures. But no question, CRE's a concern."
Falling property values also make it harder for lenders to make new loans. This could slow commercial loan growth in the coming quarters.
"Delinquencies are expected to rise, especially for the floating rate loan borrowers, particularly on properties such as offices facing strong headwinds," Trepp analyst JP Verma said. "On the supply side, lenders are expected to increase underwriting standards and scrutiny in originating new loans."
Matt Deines, president and CEO of First Northwest Bancorp in Port Angeles, Washington, said "there is particularly significant concern" about office and apartment buildings taller than five or six stories. These tend to cluster in the downtowns of major cities such as Seattle, where his $2 billion-asset bank operates. A combination of the rising cost of living and remote work is hitting these properties hard, Deines said.
"I do think there's going to be some real pain there," he said.
Deines said First Northwest had, fortunately, focused its CRE lending on smaller, suburban properties that are not as vulnerable. But he said banks with exposure to skyscrapers are nervously scrutinizing their CRE books.
However, the banking industry on the whole is far better capitalized than it was heading into the last real estate meltdown in 2008, Deines said. Lenders also ramped up underwriting and avoided the risky lending practices that led to the financial crisis. As such, he thinks the banking sector will weather CRE problems and any recession without facing crippling levels of loan losses.
"There could of course be exceptions — and everyone wants to know who the exceptions could be — but overall, banks are far better buffered now than in the past to withstand challenges," Deines said.
