It’s been over a year since the shocking collapse of Silicon Valley Bank (SVB) and Signature Bank, but the fallout continues to reverberate through the U.S. regional banking sector. As these smaller lenders prepare to report first-quarter earnings from April 16 onward, industry watchers anticipate they’ll be forced to set aside more money to cover potential losses on commercial real estate (CRE) loans and offload more property debt from their books.
The renewed focus on regional banks’ CRE exposure was sparked by New York Community Bank’s surprising Q4 loss driven by markdowns on its real estate portfolio, raising fears about other lenders’ vulnerabilities. Multifamily properties with over five units are a particular concern given that regional banks originate most such loans.
In a report by Reuters, the office sector’s struggles are well-documented as remote work remains prevalent post-pandemic, leaving many buildings plagued by high vacancies that strain borrowers’ ability to service debt. But even residential multifamily is facing headwinds, especially in pricey cities like New York and San Francisco where rent hikes were severely restricted pre-COVID based on low interest rates and inflation at the time.
Data from the International Monetary Fund (IMF) shows U.S. banks’ non-performing CRE loans as a percentage of their total portfolios doubled from 0.4% to 0.81% over the past year as the sector’s health deteriorated. The IMF noted lenders have been steadily increasing provisions for souring CRE debt.
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Morgan Stanley’s Forecast
In a research note, Morgan Stanley forecast the CRE reserve ratio for regional banks could climb by 10-20 basis points this year.
While delinquency rates on CRE loans held by banks remain relatively low at 1.2% for 30-day past dues, according to S&P Global Ratings, the rating agency has already downgraded its outlook on five U.S. banks including M&T and Valley National due to CRE market stresses that may impair asset quality.
As banks look to shed riskier CRE exposures, some are expected to sell property loans at steep discounts to private equity investors and alternative lenders hungry for higher-yielding debt. Regulatory filings show regional lender PacWest sold construction loans at a $200 million discount last year, while the successor to failed Signature offloaded a 20% equity stake in a $16.8 billion loan portfolio to Blackstone at nearly a 30% markdown.
Looking ahead, while few expect a catastrophic systemic event, the road ahead for regional banks appears bumpy as they navigate the CRE downturn. Cost-cutting, capital raises, and further loan sales could feature prominently as smaller lenders aim to fortify their buffers against escalating real estate risks in an uncertain economic climate shaped by lingering inflation, higher interest rates, and potential recessionary pressures.
The U.S. regional banking sector must steer through carefully to avoid compounding the damage from SVB’s 2023 failure.
