The threat of a looming wave of maturing commercial real estate loans has been well known to investors, but it’s possible that the metrics they use to protect against risk are flawed. Many investors avoid bank stocks with high concentrations of commercial real estate (CRE) exposure. However, this metric may miss banks that have riskier loans on their books despite lower CRE concentrations. For this reason, investors may want to take a closer look at the types of loans a bank makes. In doing so, they may find that some larger banks are in a precarious position than their CRE concentration suggests. About 30% of CRE’s outstanding debt is due between 2024 and 2026, according to data provider Trepp. When that debt comes due and property owners begin to refinance, borrowers will face much higher debt payments due to rising interest rates, and the economy could become untenable, especially since many office properties have declined in value. Owners may decide it’s easier to just return the keys and leave. Heightened concerns about default risk are clearly weighing on bank stocks, which are already struggling with headwinds from higher interest rates. Indeed, the gap between the KBW Banking Index (up about 4% YTD) and the SPDR S&P Regional Banking ETF (KRE) (down 12% YTD) compared to the S&P 500 Index (up nearly 14%) now even wider than during the regional banking crisis in the spring of 2023, UBS analyst Erika Najarian wrote in a research note on Thursday. For now, non-performing loans are contained. About 1.23% of all outstanding CRE loans are considered at risk, according to CoStar, but the trend may be going in the wrong direction. At the end of the first quarter, the Federal Deposit Insurance Corporation reported that the amount of delinquent or non-performing real estate loans totaled $35 billion, up 9% from the fourth quarter of 2023 and 59% higher than the same period of the year. . ago, marking the highest level in 11 years. Investors are punishing regional bank stocks, especially when a bank’s commercial real estate exposure exceeds 300% of its total capital. This is a benchmark that the Federal Reserve considered excessive. Stephens analyst Matt Breeze said many of the Northeast and Mid-Atlantic banks he covers that have CRE concentrations above 300% are trading below overall book value. But CRE concentration should not be the only consideration for investors. NPLs Stephens analysts noted that FDIC bank profiles for the first quarter showed that banks with more than $250 billion in assets are those seeing an acceleration in NPLs, despite having some of the lowest concentrations of CRE. The share of problem loans in this group in the first quarter was 4.48%. Analysts said this is much higher than the 1.47% rate at regional banks and 0.69% at local banks. This trend likely reflects that some of the larger banks have access to large, prime office properties in major metropolitan areas. These properties have been particularly hard-hit in downtowns, which have been battered by the pandemic, as well as by companies looking to reduce their real estate needs in the era of hybrid work. The Federal Reserve Bank of Kansas City also noted this in its report, saying that the default risk of office properties increases with the size of the property. It is estimated that if a property is larger than 500,000 square feet, the risk of default is 22%, while for a building less than 150,000 square feet, the risk of default may be less than 5%. In other words, community banks may be less risky than CRE data suggests. There’s no one metric that can be easily isolated, Breese said, but investors might want to consider the average loan size at a bank, as well as which asset classes are exposed to interest rates and some other negative forces. “I think you’re starting to carve out a much smaller piece of that pie,” he said in an interview. In Breeze’s coverage area, his top stocks are NBT Bancorp., Webster Financial and Valley National Bancorp. While the latter two have some exposure to New York real estate, both banks benefit from strong management teams, he said. (New York real estate markets are experiencing both falling office prices and rent-controlled multifamily dynamics.) Still, even these stocks are likely to struggle as long as interest rates remain high and concerns about CRE persist. Connecticut-based Webster’s stock is down more than 22% year to date, and New Jersey-based Valley National is down 40%. NBT, whose shares are down about 16% since the beginning of the year, is doing slightly better. NBTB YTD Mountain NBT Bancorp stock YTD. Breeze views NBT as a defensive and offensive play as it is well funded and has a low CRE concentration of 203%. It also has an attractive opportunity as a bank in upstate New York, located in an area that has seen a lot of investment in semiconductor manufacturing from companies like Micron Technology. UBS’s Najarian said the bank screened stocks that were interest rate sensitive and had the greatest exposure to CRE, and Providence, Rhode Island-based Citizens Financial Group had “the most compelling individual ‘story’.” She cited factors such as private banking. thrust and reduced drag from swaps as two catalysts. At larger banks, sentiment could improve, Piper Sandler analyst R. Scott Cifers said. In early June, he explained that larger banks have fewer wildcards outstanding and are improving fundamentals, such as the chance of improving net interest income and a rebound in investment banking business even with higher interest rates. Siefers also likes Citizens Financial and Cleveland-based KeyCorp. He has an Overweight rating on both stocks. Citizens is up less than 3% year to date, while KeyCorp. shares fell nearly 7% over the same period. “Investor interest focused solely on the financial sector has increased, although generalists still seem largely sidelined,” Siefers writes.
