There's a disconnect right now between jittery investors' perceptions of banks' commercial real estate exposures and the same banks' confident assertions about those portfolios. And it's showing no signs of easing.
Concerns about the riskiness of some CRE loans, especially in the office sector, have been hitting banks' stock prices like a game of Whac-A-Mole. Although it seems safe to assume that the asset class will experience some stress, experts say it's difficult to accurately assess individual loans without information that the banks often don't provide.
As banks begin to report second-quarter earnings next month, many institutions with outsized CRE portfolios will seek to share enough information to convey stability without getting so deep in the weeds that they put investors on alert or break confidentiality agreements.
The asset class is idiosyncratic, depending on variables like geography and sector, but banks' relationships with their borrowers and sponsors can be part of a story unseen by the public.
Jon Winick, CEO of the bank advisory firm Clark Street Capital, said there are reasons to worry about commercial real estate, but that data from banks' earnings reports don't jibe with a doomsday story.
"Now, the apocalyptic narrative could be completely accurate," Winick said. "But you have to concede that there is a difference between the actual facts on the ground, what banks have seen so far in non-performing assets and what the market perception is."
That nuance may not help banks much, though, given that investors are painting all CRE-heavy banks with a broad brush.
"When it comes to investing in banks, with investors, a lot of times they shoot first and ask questions later," said Brandon King, an analyst at Truist Securities, in an interview. "You see that with the stock price reactions."
Banks and thrifts hold close to $3 trillion of commercial real estate debt in the United States, according to Trepp data cited by the Federal Reserve Bank of St. Louis. Non-performing loans and net charge-offs have increased since the smooth-sailing days of 2021 and 2022, but are still hovering around, or even below, pre-pandemic levels at most institutions. CRE delinquencies are still on the rise, but the pace of the increase has begun to slow down, per data from S&P Global Market Intelligence.
Still, fresh worries continue to stir up markets. In the last few weeks, both Bank OZK and Axos Financial saw their stock prices take one-day hits of up to about 15% following reports from analysts and investors.
In May, a Citigroup analyst double-downgraded Little Rock, Arkansas-based OZK from "buy" to "sell" due to apprehension about two of its property loans — involving a 1.7 million square-foot life sciences construction project on the San Diego waterfront and a mixed-use property in Atlanta. In the report, Citi analyst Benjamin Gerlinger wrote that the rating change was rooted in the lack of tenant demand at the life sciences development and the 300,000 square feet of office space in the Atlanta building.
In response to Citi's report, Bank OZK issued more information about the loans in a public filing, including loan-to-value ratios and the amount funded so far. The bank also reiterated confidence in its projects and capital partners. The additional disclosures helped stabilize the $36 billion-asset bank's stock price.
However, Citi reiterated its sell rating, and OZK's value has continued to slide, falling 23% in the last month. Piper Sandler analysts wrote in a note that they were maintaining their "overweight" position in OZK, adding that although the bank may record losses in its CRE portfolio, investors' reaction to the Citi report was excessive.
A week after Citi released its report on OZK, Hindenburg Research disclosed its short position in Axos Financial, which the investment firm said, per its research, was "exposed to the riskiest asset classes with lax underwriting standards and a loan book filled with multiple glaring problems."
Axos clapped back in a public filing, claiming that the Hindenburg report contained "a series of inaccuracies and innuendo that included false, incomplete and misleading allegedly factual information" regarding its loans. The bank also provided additional information to rebut assumptions made in the Hindenburg report, and wrote that its loan structure provides "a strong collateral protection even in adverse market scenarios."
Axos' stock price recovered some of its lost value, but it has still fallen more than 16% in the last month. Axos declined to comment for this story. OZK did not reply to multiple requests for comment.
A recent analysis by the St. Louis Fed suggests there's a correlation between higher CRE exposure and negative stock returns at U.S. banks.
As regulators have become more focused on banks' CRE exposure, those lenders with higher concentrations in the asset class have seen valuation dips, per a recent note by Piper Sandler analyst Stephen Scouten. In the last month, the banks whose stock values have declined the most are the ones with the highest CRE concentrations.
Investors who are brave enough to take the plunge by buying regional bank stocks loaded with CRE could have a big upside opportunity, given the right market conditions, Scouten said.
"We found an important part of this exercise to be our realization that many of these banks are being painted with the same broad brush, but that there are nuances within each bank's exposure that will likely lead to a litany of different outcomes," Scouten wrote.
Scouten noted that regulators seem to be pushing banks not to allow their CRE portfolios to exceed more than 300% of their risk-based capital. At Axos, the CRE to risk-based capital ratio was 238.8%, and Bank OZK's was 365.9%, per Piper Sandler's most recent data.
OZK and Axos are the latest examples of banks facing stock turbulence due to CRE worries, but they aren't the most extreme cases. Earlier this year, New York Community Bancorp's stock price tumbled some 80% after it announced that it was preparing for major unexpected losses in its real estate portfolio. (New York Community's problems went beyond its commercial real estate exposure. The company also disclosed deficiencies in its risk management and underwriting, finally raising a $1 billion lifeline investment to overcome investors' fears in the spring.)
Amid concerns about CRE credit quality, Moody's Investors Service also announced earlier this month that six banks were under review to be downgraded. F.N.B. Corp., First Merchants Corp., Fulton Financial, Old National Bancorp, Peapack-Gladstone Financial and WaFD — all regional banks with major CRE portfolios — are on the credit agency's list for a deeper dive.
At Peapack-Gladstone in New Jersey, one-third of the bank's total loans involve rent-regulated multifamily properties, according to Moody's. Such loans have also been a source of concern for New York Community. Peapack-Gladstone did not respond to a request for comment.
David Fanger, a senior vice president at Moody's, said the ratings firm evaluates CRE concentration in conjunction with other earnings metrics to score a bank's credit performance. He said equity markets are more precarious.
"When there are public announcements about commercial real estate, that can certainly drive the equity market, fairly or not," Fanger said. "The fact is, banks are opaque. Commercial real estate lending, in particular, is opaque."
The broken telephone dynamic between what banks say and how markets behave isn't new. Fears about how CRE losses will impact banks have persisted for years, but they continue to build, and experts say that more institutions will face choppy waters because of their concentrations in the sector.
More disclosure by banks, and more patience from investors, could steady the ship, Winick said.
"I do believe some sort of storm is coming. It's just, we don't know what it'll look like," he said. "The mistake the regional [banks] will make is to completely deny the issue…. You can say the doomsayers are exaggerating, but you have to acknowledge that there are issues."
Polo Rocha contributed to this story.
