The looming wave of maturing commercial real estate loans poses a significant threat to investors, with many financial institutions facing the risk of default. While investors have been using metrics such as avoiding bank stocks with high concentrations of commercial real estate (CRE) exposure to protect themselves from this risk, there are flaws in this approach. It is essential to take a closer look at the types of loans that banks hold to truly assess the level of risk they face.
Approximately 30% of outstanding CRE debt is set to mature between 2024 and 2026, leading to challenges for property owners looking to refinance. Rising interest rates will result in higher debt payments, making it economically unviable for borrowers. This could potentially lead to defaults, with property owners opting to hand back the keys and walk away. The concern over default risk has already had a substantial impact on bank stocks, exacerbated by the headwinds of higher interest rates.
While troubled loans are currently contained, data indicates a troubling trend. The Federal Deposit Insurance Corp. reported that the amount of real estate loans past due or in nonaccrual status has risen by 9% from the fourth quarter of 2023 and 59% higher than the same period a year ago. This marks the highest level in 11 years, indicating a deteriorating situation in the commercial real estate lending space.
Investors have been punishing regional bank stocks with high CRE exposure, but this may not be the only factor to consider. Larger banks with lower CRE concentrations may still be at risk due to exposure to high-profile office properties in major metropolitan areas. The trend of troubled loans is accelerating in banks with more than $250 billion in assets, despite having lower CRE concentrations. The risks associated with large office properties in downtown areas affected by the pandemic highlight the need to look beyond the CRE concentration metric.
Diversifying Risk Assessment
According to analysts, investors should consider multiple factors when assessing the risk associated with commercial real estate loans. Metrics such as average loan size, exposure to different asset classes, and sensitivity to interest rates should all be taken into account. By isolating these variables, investors can gain a more comprehensive understanding of a bank’s risk profile. It is crucial to acknowledge that there isn’t a single metric that can paint the full picture of a bank’s exposure to commercial real estate risk.
Stock Picks and Recommendations
Analysts have highlighted certain banks as potential investments despite the challenges in the commercial real estate lending landscape. NBT Bancorp, Webster Financial, and Valley National Bancorp have been identified as top stock picks due to their strong management teams and favorable risk profiles. While these banks may benefit from specific market conditions, the overarching concerns surrounding interest rates and CRE persist, impacting their performance.
The Road Ahead
As interest rates continue to influence market dynamics, the future remains uncertain for banks with exposure to commercial real estate loans. While larger banks may see improvements in sentiment and fundamentals, the broader economic landscape poses challenges for financial institutions of all sizes. Investors must remain vigilant and diversify their risk assessment strategies to navigate the evolving commercial real estate lending market.