U.S. Banks and Commercial Real Estate Loans

By: Arnish Shah and Mohamed Ilyas Lakdawala
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The U.S. commercial real estate (CRE) sector has been under intense pressure as interest rates have risen over the past few years. Higher borrowing costs have dampened commercial property prices by making investments in the sector more expensive, while slowing economic activity has reduced the demand for commercial properties.

Particularly, commercial office spaces have seen major structural shifts after the COVID-19 pandemic. Work-from-home and hybrid working cultures have resulted in declining occupancy levels across commercial office spaces. Based on Visible Alpha consensus, leading U.S. office REITs’ portfolio occupancy rates are expected to drop from 94.2%** in 2019 to approximately 87.7% ** in 2024. Higher borrowing costs and low occupancy rates have been a stress on banks exposed to potential defaults by borrowers in the sector.

Furthermore, uncertainty over when the U.S. Federal Reserve may cut interest rates this year has exacerbated challenges faced by the CRE sector. Several U.S. banks are still grappling with the pressure from their significant exposure to the commercial real estate sector, which has been unsettled by prolonged high interest rates and vacant office buildings. In this article, we analyze over 100 U.S. banks with exposure to commercial real estate loans and examine where the sharpest pain is expected to be felt among both national and regional U.S. banks.

Small Banks Larger CRE Loan Exposure

Concerns about commercial real estate have been particularly pronounced among small regional banks in the U.S., sparking unease among investors, especially in the wake of several bank collapses last year and earlier this year. For instance, Silicon Valley Bank, Signature Bank, First Republic Bank, Heartland Tri-State Bank, and Citizens Bank of Sac City collapsed last year, followed by Republic First Bank in late April this year.

When compared to their respective asset bases, smaller regional and community banks have greater CRE exposures. According to the Visible Alpha consensus analysis of 104 U.S. banks with CRE exposure, smaller banks with total assets between $0-$10 billion have approximately 48.2% of their total loans tied to commercial properties. In contrast, larger banks with assets exceeding $100 billion are estimated to have a more modest 13.2% exposure to commercial loans in 2024.

Some of this can be understood as smaller banks are local lenders and have a competitive advantage in their local geographies. At the same time, the larger banks have been subject to greater regulatory scrutiny which has discouraged them from expanding their CRE loan portfolios. However, this discrepancy underscores the risk faced by smaller and to some extent mid-sized banks that lack diversified portfolios, potentially leading to issues with commercial loan delinquency impacting their overall financial health.

Figure 1

Commercial Real Estate Loans to Common Equity Tier 1 (CET1) Ratio

To dive deeper into the risks faced by banks with exposure to the CRE sector, it’s important to consider the commercial real estate loans to the common equity tier 1 (CET1) ratio. This ratio measures a bank’s exposure to commercial real estate relative to its core equity base. Regulatory guidelines suggest a concentration ratio limit of 300% for all CRE loans. Banks exceeding this threshold may face increased scrutiny from regulatory bodies, such as the U.S. Federal Reserve or the Federal Deposit Insurance Corporation (FDIC). In extreme cases, a bank may be required to take corrective action, such as divesting its commercial real estate loans or reducing its overall size to ensure that it can operate safely and soundly.

Visible Alpha consensus data indicates that small regional U.S. banks in the $0-$10 billion asset range are projected to have an aggregate CRE to CET1 ratio of 366.4% in 2024, slightly down from 377.3% in 2023. In comparison, banks in the $10-$100 billion asset range are expected to have a ratio of 313.7%, while those above $100 billion in assets have a much lower ratio of 86.4%.

Table 1

Source: Visible Alpha consensus (August 01, 2024)

With higher CRE exposures, the loan portfolios of small and mid-sized banks are exposed to property value fluctuations with higher risks of potential loan losses. In comparison, the largest banks often have more diversified loan portfolios leading to lower exposure ratios.

In the +$100 billion asset group, New York Community Bancorp (NYSE: NYCB) is the only bank that stands out with an estimated CRE to CET1 ratio of 617% in 2024, with CRE loans being NYCB’s core business. The bank is currently working on a turnaround strategy, offloading some CRE loans and diversifying its balance sheet.

The $10 to $100 billion asset group (mid-sized banks) has the largest number of banks with a CRE to CET1 ratio greater than 300%. The table below highlights the top 10 banks with the highest forecasted CRE concentration ratio in the mid-size bank category.

Table 2

Source: Visible Alpha consensus (August 01, 2024)

The table below, focused on small banks (assets under $10 billion), highlights the top 10 banks with the highest estimated CRE concentration ratios.

Table 3

Source: Visible Alpha consensus (August 01, 2024)

In conclusion, the current environment, marked by higher interest rates, lower property prices, and increased vacancy rates, has significantly increased the risk associated with commercial real estate. As a result, banks overly exposed to these sectors are at a heightened risk compared to those with minimal exposure or diversified portfolios. Overall, of the 104 banks covered by Visible Alpha with CRE exposure, 55% have a CRE to CET1 ratio of above 300%, with a majority of them in the $0-10 billion or $10-100 billion asset category.

**Based on average portfolio occupancy rates of 14 leading U.S. office REITs, including Boston Properties (NYSE: BXP), Vornado Realty Trust (NYSE: VNO), Alexandria Real Estate Equities (NYSE: ARE), and others.