Regional banks facing credit losses for commercial real estate: Moody's study

By Steve Gelsi

Moody's sees material exposures to higher-risk office and construction loans by regional banks.

A survey of commercial real estate exposure by U.S. regional banks reveals increasing asset risk and potential credit losses as loans mature over the next 18 months, Moody's Investors Service said.

With U.S. banks providing more than half of U.S. commercial real estate debt financing, a survey of 55 banks by Moody's shows that lenders have faced higher interest rates and a structural shift in demand as more people remain working from home after the COVID 19 pandemic.

"This has stressed the debt-servicing capacity of sponsors as commercial real estate valuations decline," Moody's analyst Stephen Lynch said in a research note. "At the same time, strained banking conditions have caused many banks to tighten underwriting, limited commercial real estate (CRE) lending activity."

Banks are grappling with "material" commercial real estate maturities through 2024 that are about equal to 46% of the adjusted tangible common equity estimates by Moody's. Tangible common equity (TCE) is used as a measure of a bank's ability to absorb losses.

Moody's survey of banks showed that higher risk office loans accounted for 26% of tangible common equity, while construction loans accounted for 30% of tangible common equity. These two loan types are "most likely to drive credit losses," Lynch said.

Moody's flagged other issues with banks including commercial real estate loans with properties that are currently generating insufficient cash flow to pay debt obligations. On this metric, the median bank had 13.5% of its tangible common equity exposed to commercial real estate loans with debt-service coverage ratios below 1.0 times.

In response to risks tied to commercial real estate loans, banks in the second quarter built up their loan loss allowance coverage. (See chart below).

Banks that saw a decline in their loan loss allowance coverage in the second quarter compared to the previous quarter include Dime Community Bancshares (DCOM), Principal Financial Group, (PFG), Axos Financial (AX), Old National Bancorp (ONB) and Cadence Bank (CADE), and First Merchants Bank (FRME).

Banks that have grown their loan loss allowance coverage include Prosperity Bancshares (PB), Merchants Bancorp (MBIN), New York Community Bancorp (NYCB), Webster Financial (WBS), Bank OZK (OZK), United Bancshares (UBSI), Synovus Financial (SNV), Pinnacle Financial Partners (PNFP), Fulton Financial (FULT), Associated Bank (ASB), Zions Bancorp (ZION), M&T Bank (MTB), BankUnited (BKU) and Bank of Hawaii (BOH).

Also read: How the U.S. housing market got stuck in the '80s

-Steve Gelsi

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09-06-23 1418ET

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