The collapse of several U.S. regional banks and Credit Suisse last year sparked fears of an imminent financial crisis. By summer 2023, however, the panic subsided. But in February, New York Community Bank (NYCB) reignited concerns with $2.4 billion in losses, a CEO dismissal, and credit downgrades from Fitch and Moodys. This led to NYCB’s stock plummeting by 60%, erasing billions from its market value, and a mass exodus of depositors.
The current banking turmoil is partly due to the fact that many regional banks hold large portfolios of distressed commercial real estate (CRE) loans, according to Peter Earle, a securities analyst and senior research fellow at the American Institute for Economic Research. Many banks are using an approach called “extend and pretend,” where they extend loan repayment timeframes for insolvent borrowers in the hope that market conditions will improve.
NYCB’s struggles stemmed from its heavy exposure to New York landlords struggling with solvency. In January, it had over $18 billion worth of loans tied to multifamily, rent-controlled housing developments. Last year’s banking crisis took down banks like Signature Bank due to high levels of uninsured deposits from wealthy individuals and corporations. These clients rushed to withdraw their money when the bank faced losses in the cryptocurrency market.
Regional banks also struggled with aggressive Federal Reserve interest rate hikes aimed at tackling inflation, which led to a decline in the value of bond portfolios held by many banks. This sparked concerns about banks’ solvency in case they needed to sell their bond holdings. As stock traders sold shares of banks vulnerable to interest rate risk, customers became spooked and started withdrawing their money.
Out of approximately 130 regional banks in the United States, each with assets between $10 billion and $100 billion, many have found a profitable niche lending to real estate investors. However, commercial landlords have faced challenges in recent years, such as office vacancy rates increasing due to companies adopting remote work and reevaluating their office space needs.
TD Bank estimates that another $535 billion worth of loans will mature in 2025, which means higher financing costs for commercial landlords even as rental income shrinks. This impairs debt service ratios and increases the riskiness of new loans for banks. Other issues include retailers dealing with escalating “retail shrink,” or losses from shoplifting and inventory damage, prompting store closures in high-crime urban areas.
The Fed and FDIC maintain they are monitoring loan situations and that a disaster is not imminent. They reportedly work behind the scenes with banks to address outstanding problems within their loan portfolios. Earle suggests that rezoning some properties, such as turning malls or office buildings into residential spaces or assisted living facilities, may help banks become more profitable in the future.
In the meantime, regional banks are looking to reduce their CRE loan portfolios but often must do so at a significant loss in a buyers’ market. This will likely result in a reduced capital base for these banks, necessitating either the selling of more equity or being acquired by larger banks. Until the CRE market recovers, it is uncertain where regional banks can find profitability to attract investors and rebuild their capital base.