06 May Bank Exposure to Commercial Real Estate (CRE)
The demand for Commercial Real Estate Loans has increased exponentially in the past years. Value for land, acquisition, construction, and lending is also rising, leading to more borrowing. During the first quarter of 2023, the banks’ CRE loans surpassed $3 trillion, according to a FDIC report. Over 90% of banks held CRE loans, with CRE being the largest loan category. Nonbank financial institutions have also played a significant role in CRE lending.
However, CRE comprises of different subsectors, and not all are doing well. In 2022, four out of the five CRE property types performed well, with industrial properties taking the lead. Attributed to this industrial property growth was an increased demand for warehousing and distribution.
Office property demand is low as demand for remote work increases. On the other hand, multi-family property demand is high compared to the single-family housing market. High single-home costs have barred most people from owning a home, keeping them on rentals. Worse still, high rental fees have hindered some potential customers, leading to slowed rent growth in the first quarter of 2023.
In 2023, consumer spending was good, which saw the retail properties perform well. Though some CRE sectors are doing well, the economic uncertainties, and high interest rates expose banks to CRE problems, and some may end up collapsing.
Bank Exposure to CRE According to Size
Banks are exposed to CRE directly by holding or issuing CRE loans to developers or commercial property owners. Banks also get CRE exposure indirectly by holding Commercial Mortgage-backed securities as investments. According to a FDIC report, banks’ CRE loans were approximately 13% of their banking assets. The remaining CRE loan is held by investors in CMBS (commercial mortgage), mortgage REITs, Insurance firms, PE firms, pension funds CLOs (Commercial loan obligations), and foreign US banks.
Just like any other loan category, CRE loans have risks and a high percentage exposes the banks to heavy CRE problems. In 2023, the number of FDIC-insured banks reduced from 4672 to 4645, while 27 of these institutions merged. And when these losses hit, investors suffer. But when these financial institutions close due to bad debt, you will only hear about the big banks.
A report published by the FDIC showed that, between May and November 2023, three banks collapsed, while two other small banks collapsed the same year. None of these banking institutions had bad CRE loans. This shows how having high-percentage CRE loans exposes banks to CRE problems.
Banks’ Exposure to CRE by Asset Size
Banks of different sizes are exposed differently depending on the percentage they allocate to CRE. Here is a breakdown of bank exposure to CRE according to FDIC.
Big Banks
They have over $250 billion in assets and 6% of CRE loan allocations. While they do not have big CRE allocations, they are not immune to bad debt. They are on 14 and hold over 50% of the banking assets, and if one collapses, there will be a major shake-up in the financial industry.
Medium Size Banks
Medium-sized banks have $10 Billion -$250 Billion with 17% CRE loan allocations. Currently, there are only 127 banks in these categories, and 16 of them have $ 100 billion of banking assets. If some banks collapse, the effect will be felt, and it’s likely to hit the headlines.
Small Banks
Small banks are highly exposed to CRE and have between $1 Billion and $10 billion in assets, with 31 % of these assets going to CRE loans. We have 700 of these banks. When losses hit the CRE industry, some of these banks will be more affected, and some may not be published.
Community Banks
There are 2589 community banks with assets between $100 Million and $1 billion and CRE loan allocations of 28% of their total assets. Community banks are said to be highly exposed to CRE problems. However, community bank lending remains crucial to the CRE industry as economic uncertainty and high loan interest rates pose risks to bank portfolios.
When bad CRE debt hits, more community banks are bound to close. You may not hear about it, as more attention is on big banks, which hold a small portion of the CRE lending industry.
Conclusion
The banking system pays more attention to big banks than community banks. However, despite community banks’ high exposure to CRE problems, they play a significant role in the industry. All is not lost, though, as the CRE industry growth continues to rise for four of its five sectors, which projects massive growth in the industry in the coming years.
