U.S. federal regulators warned late last year that about two dozen banks in the U.S. had portfolios of commercial real estate loans that would merit greater scrutiny, a sign that the banks may face pressure to bolster their reserves.  The regulator said they would pay closer attention to banks that rapidly piled up such loans worth more than three times their total capital.

The three U.S. regulators, which include the Federal Reserve, Federal Deposit Insurance Corp, and Office of the Comptroller of the Currency, indicated that they would focus on the portfolios of banks that had grown at least 50% in the past three years. Banks that crossed that threshold include Valley National Bancorp (VLY), WaFd Inc (WAFD), and Axios Financial.  Shares of those regional banks and others have declined since late January on concerns about their commercial property exposure and the prospect that regulators might force some lenders to bolster their reserves or cut dividends.

Keith Noreika, acting comptroller of the currency (COC) in 2017, said, “We’re at the warning stage.” Earlier this month, shares of New York Community Bancorp (NYCB) slumped to a 27-year low after it cut its dividend and boosted its loan loss reserves due to losses in its commercial real estate loans.  Fed Chair Powell said in a 60 Minutes interview this month that “there are some regional banks that have concentrated exposures in these areas that are challenged, and you know we’re working with them.  It feels like a problem we’ll be working on for years.”

A review by Bloomberg found that 22 banks with $10 billion to $100 billion of assets hold commercial property loans three times greater than their capital.  The figure was even higher among banks with less than $10 billion of assets, as 47 had outsized portfolios, of which 13 had grown rapidly.  The markets are watching for fallout at banks as higher interest rates drive down commercial property values.  With vacancy rates in commercial real estate higher than before the pandemic, commercial property values have tumbled, making it hard for banks to extend debts and strike deals with borrowers.

According to commercial real estate data provider Trepp, banks will face roughly $560 billion of commercial property loan maturities by the end of 2025.  With the Fed signaling a slow approach to lowering interest rates, commercial property values may remain under pressure for longer, making it harder for banks to reduce their exposure to commercial real estate.  The former head of the COC, Noreika, said that predictions for how the situation will play out are difficult because loans are idiosyncratic and can’t be “painted with a broad brush,” so “it’s sort of one of those things that’s not a problem until it’ s a problem.”

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