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Investors’ psychological expectations play a pivotal role in the financial markets. Recently, bank stocks have faced significant pressure from the real estate sector. Since New York Community Bank had to set aside reserves due to unexpected loan losses, the market has been closely monitoring the commercial real estate loan situation of banks.
According to the latest reports, U.S. regulatory authorities have shut down several regional banks operating in Pennsylvania, New Jersey, and New York, including Republic First Bank, marking the first instance of an FDIC-insured bank failure in the U.S. this year. In light of this, Barron’s magazine has conducted a study on banks highly concentrated in commercial real estate loans, continuing our analysis from a year ago.
Our basic conclusion is that these banks seem to have exceeded market expectations in their risk-control abilities. While many of the documented banks remain the same as last year, including Silicon Valley Bank, Bank of the Ozarks, and the parent company of Washington Federal Bank, WaFd, some banks like PacWest Bancorp dropped off the list due to forced mergers.
Other banks made it onto this list of concentrated lenders due to mergers, while banks such as Merchants Bancorp retained more loans on their books due to high interest rates causing borrowers to postpone refinancing at fixed rates. For instance, the Miami Brickell Flatiron condominium was financed by a loan from Bank of the Ozarks.
Banks with substantial commercial real estate loans, although experiencing an increase in non-performing loans, are still around the industry’s average level. Their capital levels and profit margins remain stable. These banks claim their focus on commercial real estate loans is because it’s their area of expertise, and they have not issued loans on a large scale to downtown office buildings with high vacancy rates.
However, investors don’t seem convinced. Over the past year, the regional bank ETF has dropped more than 20%, while the S&P 500 index has achieved a 28% growth. In our survey list, most banks focused on real estate loans have a lower price-to-earnings ratio than other banks.
The market still vividly remembers the bad real estate loans of the 1980s and early 1990s that led to significant losses for many banks and savings and loan institutions. Another occasion was in 2008 when banks’ imprudent real estate lending nearly threatened the safety of the U.S. financial system.
Despite this, regional banks mentioned in Barron’s magazine insist that the situation this time is different. They maintain that they have sufficient capital and have adopted a more conservative strategy in real estate lending. George Gleason, CEO of Bank of the Ozarks, stated that despite witnessing a stock sell-off of more than 11% over a period of time, he has not felt panic. Gleason believes investors tend to lump different lending banks together, explaining, “When you talk about commercial real estate, you are actually talking about thousands of different categories.”
Financial regulators pay special attention to banks with a high concentration in commercial real estate loans. Especially when a commercial bank’s commercial real estate loans exceed 300% of its capital and have at least a 50% increase in the past three years, or construction and development loans exceed 100% of its capital, regulators will pay extra attention.
By the end of 2023, Bank OZK ranked first among large banks in terms of concentration in commercial real estate loans. Over the past year, Bank OZK not only maintained profitability but also showed excellent performance in terms of capital adequacy ratios among all US banks with assets over $10 billion. In the 27 years since it went public, Bank OZK’s stock has increased tenfold compared to the S&P 500 index.
WaFd Bank’s CEO Brent Beardall stated that they provided loans to fully rented apartment buildings in the Northwest, considering risk diversification. Beardall explained: “If we try to diversify funds into other areas, the risk would significantly increase.”
Commercial real estate has always been a sensitive sector in financial markets, even before the pressures of the current mixed-business model and rising interest rates. Especially after the savings and loan crisis of the 1980s and 90s, federal regulators issued guidelines in 2006 setting levels for commercial real estate loans, meaning bank ledgers would be subject to additional scrutiny. The 2008 financial crisis and the COVID-19 pandemic prompted regulators to reiterate these guidelines, proposing two test standards to assess the concentration risk of banks in commercial real estate.
The first test criterion involves whether loans for non-owner-occupied commercial real estate account for over 300% of bank capital and have grown more than 50% in the past three years; the second checks whether construction and land development loans exceed 100% of bank capital. According to year-end data from S&P Global Market Intelligence, we pay attention to commercial real estate loans that exceed the 2006 guidance levels and have ranked the ten largest listed banks accordingly.
In our list, most banks concentrated in real estate lending are not the largest financial institutions in the US. Valley National Bank in New York has the largest assets in the list but is only ranked 26th in the US. The national asset rankings of other banks fall in the latter half of the top 100 banks. In dollar terms, although these banks are not the largest in commercial real estate loans, their percentage of total loans is higher compared to other banks. For example, JPMorgan Chase, Wells Fargo, and US Bank all provided huge commercial real estate loans to developers, amounting to $170 billion, $140 billion, and $83 billion, respectively.
Although commercial real estate loans account for less than 15% of other major banks, their share is more significant in the banks ranked by “Barron’s Weekly.”
According to S&P’s data, as of the end of last year, New York Community Bancorp ranked sixth in the industry with its commercial real estate loan portfolio of $48.5 billion. These loans not only accounted for 56% of the bank’s total loans but also 470% of its regulatory capital. Despite the fact that New York Community Bank’s debt growth has not been sufficient to place it on the list of Barron’s Weekly, its share price still plummeted by over 20% last Friday, with the $2.4 billion impairment charge on goodwill being the main factor for such volatility.
In the field of commercial real estate lending, Valley National Bank ranked 12th with a loan amount of $28 billion, contributing to 55% of the total loan portfolio. Meanwhile, Ozark Bank was in 17th place with $20 billion in commercial real estate loans, making up 74% of its total loans.
While these banks with concentrated lending could face difficulties without directly impacting the American banking system, as demonstrated by New York Community Bank, investor sentiment and expectations are extremely important. At the moment, bank stocks are facing serious threats due to concerns over the real estate market. Similar to many real estate loan banks in the past 18 months, these concentrated lenders have reported an increase in overdue repayments. Since the beginning of 2023, “non-performing assets” have increased from less than 0.5% to just above 0.5% in proportion to total loans and in foreclosures.
Even in such circumstances, some banks like WaFd, Massachusetts’s Rockland Trust, Alabama’s ServisFirst, and New York’s Dime Community Bancorp, have a rate of non-performing loans far below the industry average of 0.44%. This high concentration of loans to some extent reflects the economic pressure of the real estate market.
Merchants Bancorp aims to provide short-term floating-rate loans to developers building federally affordable, multi-family apartments, with penalties for prepayment. Its CEO, Michael Dunlap, pointed out that developers have delayed refinancing long-term fixed-rate loans as they wait for interest rates to drop. Although Merchants Bancorp typically offers fixed-rate loans, its expansion in the commercial real estate loan portfolio reflects changing market conditions despite developers continuing to repay their loans.
In addition to economic conditions, bank mergers are also a factor contributing to appearing on the list. Changes in growth guidance norms are often associated with loan growth requirements of a three-year cycle. For example, Umpqua Bank and Columbia Bank merged in 2023, Dime merged with Bridge Bancorp in 2021, and Valley National Bank completed three acquisitions in the last three years. Notably, many of these banks specialize in commercial real estate loans, hence their high concentration in this type of lending.
Located in Las Vegas, Axos Bank specializes in providing large mortgage loans for wealthy homeowners, and has provided funding for Donald Trump’s Doral golf resort in Miami after Deutsche Bank withdrew.
In the recent civil fraud trial against Trump, the Attorney General of New York alleged that Axos Bank’s interest rates were higher than usual. As one of the main banks for construction loans for nationally recognized projects, OZK Bank’s construction loan amount in December exceeded 237% of its total capital.
Despite facing such high loan amounts, CEO Greg Garrabrants stated that their bank is operating well. Garrabrants emphasized that the stress tests conducted by their bank during the underwriting process far exceed regulatory requirements. He further noted, “Our average net charge-off ratio is about 35% of the industry average, which means that our bank’s credit asset quality is three times the industry average.”
When it comes to the commercial real estate loan market, almost every banker believes their bank’s stocks have been oversold by investors. For instance, Ira Robbins, CEO of Valley National Bank, said his bank was wrongly compared to New York Community Bank. Robbins explained that although his bank has a significant proportion of loans in New York City, only 30% of the loans are concentrated there, and just 10% are in Manhattan. He insisted, “This is absolutely not the same type of loan.”
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