There was pretty much only one thing anyone wanted to talk about when Morgan Stanley analysts made the rounds visiting investors last month: commercial real estate.
The mounting anxiety was captured best in a Fitch Ratings report on April 2 alarmingly headlined “Global Contagion Risk Growing from Rising CRE Losses, Led by Office.”
If global contagion does emerge, there’s nowhere for banks to hide because, collectively, they’ve loaned nearly $3 trillion to office buildings, hotels, shopping centers and everything else that makes up commercial real estate in the U.S. Every bank has a piece of this business, from JPMorgan Chase and its colossal $140 million CRE loan book to several New York lenders who are much more heavily exposed relative to their modest size.
The $14 billion-in-assets Dime Community Bank, for instance, carries $7 billion worth of commercial real estate loans on its books. But its portfolio is more concentrated than any other bank with at least $5 billion in CRE loans, Morgan Stanley said, with those loans equaling 662% of the bank’s Tier 1 capital — a figure closely watched by regulators. That means the dollar amount of CRE loans on Long Island-based Dime’s books is nearly seven times larger than the capital held by the bank, potentially leaving little cushion to absorb losses should they materialize.
Several other New York-area lenders are similarly exposed. The CRE loan-to-capital ratio at Long Island-based Flushing Bank is 653%, 590% at New Jersey-based Valley National Bank, and 587% at New Jersey-based ConnectOne Bank. It’s 545% at Long Island-based New York Community Bancorp, which required a $1 billion infusion last month after concerns grew over its CRE portfolio.
Those exposures are large compared to the median figure for all banks of 215%, Morgan Stanley said.
The biggest lenders tend to have lower CRE exposures because they serve a larger and more diverse customer base. JPMorgan’s $140 billion CRE loan book is big by any measure, but CRE loans amount to 64% of the giant bank’s capital. At Bank of America, it’s 42%, and Citigroup 18%.
Smaller banks that responded to inquiries from Crain’s insisted they are well-positioned to handle any difficulties and have mostly avoided the troubled office market.
Dime’s commercial real estate portfolio is about half apartment loans, which are much less risky than the Manhattan office loans that account for only $200 million of the portfolio. The bank has no past-due or non-performing office loans.
“We don’t even have one 30-day delinquency,” Chief Executive Stuart Lubow told Crain’s. “We’ve always been a very conservative lender.”
Valley National says much the same thing.
“We remain comfortable with our granular commercial real estate portfolio which is well-diversified by property type and across our geographic footprint,” the New Jersey-based lender with $60 billion in assets said in a statement. “Nearly 50% of our commercial real estate loans are outside of New Jersey and New York.”
Flushing Bank said more than a third of its CRE exposure is to medical buildings and that Manhattan office buildings account for 0.6% of net loans. Neither NYCB nor ConnectOne returned a request for comment.
Many lenders have been reappraising properties and restructuring loans to give borrowers breathing space. That has helped keep CRE losses low so far, but pressure is mounting. The percentage of CRE loans that required an extension or some other modification steadily increased in 2023, ending at 1.3% of such loans after starting at just 0.1%, according to Evercore ISI.
But a deluge may be building. With cash flows at office buildings under pressure and loans written in the days of ultra-low interest rates coming due, Fitch forecasts the delinquency rate will reach 4.9% next year for U.S office loans packaged into securities and sold to investors, up from 2.3% in February. The ratings firm said three out of four of these loans maturing in 2024 are likely to default.
Bleak outlooks such as these lead investors to conclude smaller banks will eventually be stuck with losses they can ill-afford. Shares in Dime, Valley National, and Flushing Bank all trade about 40% lower than before the crisis last year that wrecked three regional banks. In contrast, the Keefe Bruyette & Woods Bank Index, which tracks larger lenders, has regained almost all its lost ground.
Dime’s Lubow said his bank is doing what it can to show investors it avoided the land mines.
“Shorter-term investors look at CRE because it’s in the headlines,” he said. “We just stick to what we do, make good loans, build our balance sheet.”
But proving doubters wrong could take a long time. Unlike past crises, such as in 2008, it will take years for the difficulties in CRE to play themselves out.
“We expect CRE credit quality to deteriorate from here, at an accelerating rate for the next few quarters,” Morgan Stanley wrote. “We expect losses [to] eventually plateau at a higher level for the [banking] industry for multiple years as office and other CRE loans take time to work through.”
Aaron Elstein , 2024-04-04 12:03:05
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