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US regional banks seen booking more commercial property losses, loan sales

[April 17, 2024] By Saeed Azhar and Matt Tracy

(Reuters) -U.S. regional banks are expected to set aside more money to cover potential commercial real estate (CRE) losses and sell more property loans as the sector remains under pressure a year after the collapse of Silicon Valley Bank and Signature Bank.

Most multifamily loans are made by regional banks, so when New York Community Bank posted a surprise fourth-quarter loss it intensified fears about the industry's exposure to commercial real estate. Multifamily properties with more than five units are a major concern, especially since the bank had booked losses on its real estate portfolio.

Scrutiny of regional banks has increased after Silicon Valley Bank's collapse prompted by high borrowing costs that exceeded its income from low-rate loans following the Federal Reserve's aggressive rate hikes since March 2022. Many banks have unrealized losses on securities portfolios, including mortgage-backed paper.

A slew of regional banks report first-quarter earnings starting April 16.

"I expect to see more of a reserve buildup," said Stephen Buschbom, research director at consultancy Trepp.

Buschbom said office loans remain the "biggest pain points" for banks, but he also expects stress in the multifamily sector especially construction loans.

Office loans have been hit as many employees still work from home after the pandemic, leaving vacancies that make it tougher for building owners to repay their mortgages. Multifamily is also under pressure in cities like New York and San Francisco that, right before the pandemic, severely limited rent hikes on regulated apartments based on record low interest rates and inflation at the time.

Non-performing CRE loans as a percentage of U.S. banks' portfolios doubled to 0.81% by the end of 2023 from 0.4% a year earlier, the International Monetary Fund said in its semi-annual Global Financial Stability report. Banks have continued to increase provisions for bad CRE loans, the IMF noted on Tuesday.

Several analysts and investors are predicting higher reserves. Morgan Stanley forecast a 10- to 20-basis point increase in CRE reserve ratios for regional banks this year, said Manan Gosalia, an analyst at the Wall Street bank, in a research note. Aggregate provisions are 20% above consensus, she added.

Stephen Biggar of Argus Research agreed, saying high office vacancies have reduced cash flows, and the Fed's stance on keeping interest rates higher for longer makes financing expensive.

CRE holdings are significant across the U.S. banking industry, comprising 13% of large banks' balance sheets and 44% for regional banks, an Ares Alternative Credit report showed.

Reflecting investor sentiment, the KBW regional bank index is down 13.5% year to date versus the S&P bank index's 6.8% rise.

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Buildings stand in New York City, U.S., July 26, 2023. REUTERS/Amr Alfiky/File Photo

S&P Global Ratings downgraded the outlook for five U.S. banks in March because of stress in CRE markets, which it said may hurt their asset quality and performance.

The banks cited, including M&T Bank and Valley National Bancorp, declined to comment.

"The CRE delinquency rate for banks is more benign than the commercial mortgage-backed securities market, but deteriorating," Stuart Plesser, managing director (at rating agency S&P Global Ratings, told Reuters, saying he sees some reserve increase for banks.

The delinquency rate at regional banks is 1.2% for loans 30 days due as of the end of the fourth quarter, according to S&P Global, below the 4% for CMBS.

Buschbom, however, said the level of support from potential buyers, including private equity investors, will help reduce some downside risks for banks. Office loans are selling at deep discounts, while multifamily properties have smaller discounts, industry sources said.

"Numerous community and regional banks are exploring their options and, as a result, we are seeing more deal flow than we have since the global financial crisis," said David Aviram, co-founder of real estate investment firm Maverick Real Estate Partners.

A senior Wall Street banker who declined to be named discussing sensitive information said banks are expected to offload existing loans to private lenders and that those lenders would originate new loans.

Among such deals, regional lender PacWest last year sold construction loans with a $200 million discount, a regulatory filing showed.

In December Signature Bridge Bank, whose predecessor Signature Bank collapsed in 2023, sold 20% of its equity stake in a venture that held a $16.8 billion real estate loan portfolio to a Blackstone-led consortium for $1.2 billion. The discount on the portfolio was nearly 30%, based on data from the announcement by Blackstone.

"We see banks taking a more conservative approach and anticipate additional write-offs in coming quarters," said Ran Eliasaf, founder and managing partner at Northwind Group, a private equity firm over $3 billion assets under management.

"There's a much more dramatic drop in values than what the market estimated in 2023."

Analysts, however, do not expect turmoil from the banking sector's exposure to commercial real estate.

"This is a slow wreck, not a high-speed crash," said Biggar of Argus Research.

(Reporting by Saeed Azhar and Matt Tracy; editing by Megan Davies and Richard Chang)

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