“There will be more bank failures.” This was the stark message from Federal Reserve chairman Jerome Powell on Thursday, addressing the exposure of regional banks to the crisis in the commercial real estate sector.
Powell was speaking before the Senate Banking Committee and said the Fed had identified the banks most at risk.
“It’s not a first-order issue for any of the very large banks. It’s more smaller and medium-sized banks that have these issues,” he told the committee.
Recent data from Apollo Academy estimated that smaller banks hold almost 70% of the outstanding loans from commercial real estate (CRE) borrowers. Among these, it added, banks with total assets between $1 billion and $10 billion were carrying CRE loans worth an average of nearly 35% of their total assets.
Larger banks with more than $250 billion worth of assets typically had CRE exposure of little more than 5% of their assets.
Powell identified the problem as stemming from the change in working practices that were enforced during the COVID-19 pandemic, when many office staff were ordered to work from home. They were slow to return to the office, and many still haven’t leaving 19% of U.S. offices empty.
“Banks will have made loans to many of those buildings,” Powell said. “We have identified the banks that have high commercial real estate concentration and we are in dialogue with them.
He said the Fed was asking them: “Do you have enough capital? Do you have enough liquidity? Do you have plan, you’re going to take losses here? Are you being truthful with yourself and your owners?”
Powell added that the Fed had been working with these banks for some time and added: “This is a problem we’ll be working on for years more, I’m sure.”
Business Insider identified some of the regional banks with the largest exposures to CRE in a report it published in the second half of 2023.
Among them, Truist Financial Corp. (NYSE:TFC), with total outstanding CRE loans of $53.1 billion. The Charlotte, North Carolina-based bank said that it had been cutting back on CRE lending.
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Minneapolis-based U.S. Bancorp (NYSE:USB) had $52.9 billion in total outstanding CRE loans.
New York Community Bancorp has been among the worst hit after it reported earlier this year that it expected larger-than-expected losses on its CRE loans, of which it is estimated to have $51 billion outstanding.
Investors have punished NYCB for this, and the shares are 72% lower on the year.
But the sector as a whole hasn’t been targeted by short sellers and shareholders have remained calm. Both Truist’s and U.S. Bancorp’s shares are flat on the year, while the SPDR S&P Regional Banking ETF (NYSE:KRE), an exchange-traded fund that tracks the sector, has fallen just 3%.
What could provide further comfort for investors in the sector in the coming months, is Thursday’s confirmation by Powell that the Fed has been on the case for some time.
While he noted it would be a problem for some years, interest rates will likely start to come down later this year, which should make it easier for firms to service their loans.
But concerns over rising delinquency rates will persist. Even though they are currently at low levels — 1.17% at the end of 2023 according to New York Fed data — they were trending higher into 2024.
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