Investors are well aware of the threat from a looming wave of commercial real estate loan maturities, but the metrics they use to protect themselves against the risk may be flawed. Many investors have avoided bank stocks with concentrated commercial real estate (CRE) exposure. But that metric could miss banks with lower CRE concentrations but riskier loans. So investors may want to look more closely at the types of loans banks hold. In doing so, they may find that some large banks are in a more precarious position than their CRE concentrations would suggest. The Maturity Wall According to data provider Trepp, about 30% of outstanding CRE debt is set to mature between 2024 and 2026. As this debt matures and property owners look to refinance, borrowers will face much higher debt payments due to rising interest rates that could become financially unsustainable, especially given that many office properties are losing value. Owners may decide it’s easier to just hand back the keys and walk away. Growing concerns about default risk are clearly weighing on bank stocks, which are already battling the headwinds of rising interest rates. In fact, the spread between the KBW Bank Index (up about 4% YTD), the SPDR S&P Regional Banks ETF (KRE) (down 12% YTD) and the S&P 500 Index (up about 14%) is even wider than it was during the regional banking crisis in spring 2023, UBS analyst Erica Najarian wrote in a research note Thursday. For now, troubled loans are contained. About 1.23% of outstanding CRE loans are considered at risk, according to CoStar, but the trend could be heading in the wrong direction. The Federal Deposit Insurance Corporation said the amount of real estate loans that were delinquent or nonaccrual at the end of the first quarter was $35 billion, up 9% from the fourth quarter of 2023 and 59% from the same period last year, the highest level in 11 years. Investors have been harsh on regional bank stocks, especially when a bank’s commercial real estate exposure exceeds 300% of its total capital, a benchmark the Federal Reserve has deemed excessive. Stevens analyst Matt Breese said many of the Northeast and Mid-Atlantic banks he covers that have CRE concentrations above 300% are trading below their total book value. But investors shouldn’t just look at CRE concentration. Delinquent Loans Stevens analysts noted that the FDIC’s first-quarter bank profile revealed that banks with more than $250 billion in assets saw an accelerating rise in delinquent loans, even though they are some of the banks with the lowest CRE concentrations. The non-performing loan rate for this group was 4.48% in the first quarter. The analysts said that this is significantly higher than the 1.47% for regional banks and 0.69% for community banks. The trend likely reflects some of the larger banks’ exposure to large, high-profile office properties in major metropolitan areas. These properties have been hit especially hard by downtown areas battered by the pandemic and by companies looking to scale back their real estate needs in the age of hybrid work. The Kansas City Fed also noted this in a report, saying the default risk for office properties rises with the size of the property. The bank estimated that properties over 500,000 square feet have a 22% default risk, compared with less than 5% for buildings under 150,000 square feet. In other words, community banks may be less risky than their CRE exposure numbers suggest. There is no single metric that is easy to slice and dice, Brees said, but investors can consider a bank’s average loan size and asset classes that are affected by interest rates and other negative factors. “When you start slicing and dice, I think you start to see a much smaller piece of the pie,” Brees said in an interview. Within Brees’ area, NBT Bancorp, Webster Financial and Valley National Bancorp are top picks. The latter two have some exposure to New York City real estate, but both benefit from strong management teams, he said. (New York’s real estate market is dealing with both falling office prices and the trend toward rent-regulated apartment buildings.) Still, even these stocks are likely to remain tough as long as interest rates remain high and CRE concerns persist. Connecticut-based Webster is down more than 22% year to date, while New Jersey’s Valley National is down 40%. NBT, down about 16% year to date, has fared slightly better. Mountain NBT Bancorp shares, NBTB YTD. Brees sees NBT as both a defensive and offensive option with strong capital and a low CRE concentration of 203%. And as an upstate New York bank located in an area with strong investments in semiconductor manufacturing by companies such as Micron Technology, attractive opportunities await. UBS’s Najarian said the bank looked at stocks with the highest interest-rate sensitivity and CRE exposure and found Providence, Rhode Island-based Citizens Financial Group to have “the most compelling independent ‘story.'” She cited two factors as the two catalysts: stronger traction in private banking and fewer swap write-downs. Piper Sandler analyst R. Scott Sefers said sentiment may be improving for the big banks. In early June, he explained that big banks have fewer “wild cards” outstanding and improving fundamentals, including a potential recovery in net interest income and a recovery in investment banking even as interest rates rise. Sefers also likes Citizens Financial and Cleveland-based KeyCorp. Both stocks are rated Overweight. Citizens shares are up less than 3% year to date, while KeyCorp shares are down nearly 7% in the same period. “While interest from financial-only investors is growing, retail investors still appear to be showing little interest,” Sefers wrote.
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