The Banks’ Real Estate Problem

April 16, 2024 | Jessica Noviskis, CFA, Portfolio Strategist, OCIO Services, Grace Colson, Associate Research Analyst

First quarter earnings season is getting started, with the largest banks reporting first. In the wake of last year’s regional banking crisis and the potential new normal of higher-for-longer interest rates, all eyes are on the health of the U.S. financial system. With commercial real estate (CRE) still searching for its bottom, losses related to CRE exposures are of particular concern for the banking industry. There is $5.7 trillion in commercial real estate debt outstanding and small to mid-size banks hold a disproportionate amount of it, putting the group at higher risk. Regional lender New York Community Bancorp (NYCB) — with the fifth largest concentration of CRE loans, as shown above — garnered headlines earlier this year after reporting a sizeable fourth quarter loss and disclosing material weakness in the way it reviewed its loan portfolio, prompting a $1 billion emergency investment. While NYCB’s outsized exposure to rent-controlled multi-family property loans may limit contagion to the broader banking sector, risks remain. As consumers respond to the higher rate environment, bank funding costs increase, eating into the higher lending profits the sector has enjoyed. Combined with losses and provisions tied to the troubled real estate sector, banks may limit lending, which flows through to the consumer and economy. As the macro backdrop remains in flux and the consumer continues to adjust to a higher-for-longer environment, any bank weakness could become more of a threat and bears watching as earnings season continues.

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