The scrutiny on bank loans for commercial real estate intensified following New York Community Bancorp’s unexpected charge for loan loss reserves a month ago. This event led to a further decline of about 10% in the already weak stock prices of regional banks specializing in such loans.
In response, Barron’s has revisited the examination of banks with the highest concentration of commercial real estate loans, a review last conducted a year ago. The conclusion drawn this time is that these banks seem to have their risks under control to a greater extent than what the market acknowledges.
Some of the names on the list remain the same as a year ago, including Valley National Bancorp, Bank OZK, and Washington Federal’s parent company, WaFd. However, PacWest Bancorp, which was a significant lender last year, is no longer on the list due to a merger. Additionally, some banks entered the list due to mergers, while others like Merchants Bancorp attribute their high loan volumes to borrowers postponing fixed-rate refinancing amid high interest rates.
Although nonperforming loans have slightly increased at banks heavily involved in real estate lending, they remain close to industry averages. Capital levels and profit margins are also holding steady. These banks assert that their focus on commercial real estate lending stems from their expertise in the field and their avoidance of heavy lending to downtown office towers grappling with high vacancy rates.
However, investors remain skeptical. Over the past year, the SPDR S&P Regional Banking ETF experienced a decline of over 20%, contrasting sharply with the 28% rise in the S&P 500. Most of the concentrated real estate lenders identified in the ranking trade at lower earnings multiples compared to their banking peers.
The market remains cautious due to historical events like the savings and loan crisis in the 1980s and early 1990s and the financial crisis of 2008, which were exacerbated by bad real estate loans. However, regional banks on Barron’s list argue that the current situation is different. They emphasize their strong capitalization and conservative approach to real estate lending.
George Gleason, CEO of Bank OZK, remains unfazed by the recent 11% selloff in his bank’s stock, attributing it to investors grouping different lenders together under the umbrella of “commercial real estate,” despite significant differences in their lending practices. Bank OZK boasts the second-highest concentration of commercial real estate loans among large banks but has outperformed every U.S. bank above $10 billion in assets in profitability and capital ratios in 2023. Over the 27 years since going public, Bank OZK’s stock has outperformed the S&P 500 by tenfold.
Similarly, Brent Beardall, CEO of WaFd, highlights the bank’s cautious approach by focusing on lending to fully leased apartment complexes in its Northwest region to minimize risk.
Federal regulators have issued guidelines since the S&L crisis, setting thresholds for commercial real estate lending that trigger extra scrutiny. These guidelines have been reiterated after subsequent crises, including the 2008 financial crisis and the COVID-19 pandemic. Banks exceeding these thresholds face additional regulatory analysis of their commercial real estate concentration risk.
Following regional bank failures in early 2023, Barron’s collaborated with S&P Global Markets Intelligence to analyze federal bank filings at year-end 2023. They identified lenders whose commercial property loans surpass the 2006 guidance levels and ranked the largest 10 publicly-held banks in this group by assets.
The concentrated lenders highlighted by Barron’s aren’t among the nation’s largest banks in terms of assets, with the largest, Valley National Bank, ranking 26th in the country. Additionally, while these banks may not have the largest books of commercial real estate loans by dollars, their high concentration of such loans relative to their size raises concerns.
For example, New York Community Bank had the sixth-largest book of commercial real estate loans, amounting to 56% of its total loans. However, it didn’t surpass regulatory guidelines, so it wasn’t included in Barron’s list. Valley National Bank, with 55% of its loan book in commercial property loans, and Bank OZK, with 74% of its loans in commercial real estate, were included.
Although the concentrated lenders may not pose a direct threat to the banking system in terms of loan amounts, investor sentiment can significantly impact bank stocks. While some of these lenders have seen a slight increase in nonperforming assets, many remain below the industry average.
Factors contributing to high concentrations in commercial real estate loans include economic stresses in the real estate market and mergers triggering growth elements of regulatory guidelines. Additionally, some banks specialize in commercial real estate lending, such as Axos, known for super jumbo mortgage loans, and OZK, a leading originator of construction loans.
Despite their expertise and careful risk management, many of these banks feel their stocks have been unfairly penalized by investors. Valley National’s CEO, Ira Robbins, highlights the misconception that his bank is similar to New York Community Bank, emphasizing that a smaller percentage of Valley National’s loans are in New York City.