Connect CRE recently published the third installment in a four-part series, where they spoke with economic experts about lenders and banks. The first two articles, “Economic Recap and Federal Reserve Actions” and “Understanding the Mixed Signals: Analyzing the Economics of Labor and Spending,” are currently available.
In early 2023, there was widespread concern when Silicon Valley Bank and Signature Bank closed their doors. A year later in April 2024, Republic First Bancorp was seized by the Pennsylvania Department of Banking & Security with Fulton Financial acquiring its debts and deposits.
One contributing factor to Republic First’s downfall was higher interest rates which had a significant impact on their commercial real estate portfolio that made up nearly half of their loan book.
Contrary to predictions made in early 2023, these bank failures (including more recent ones like Republic First) did not lead to an overall decline in the banking industry. Economic experts interviewed by Connect CRE stated that despite some hesitation towards commercial real estate investments from banks, overall bank strength remains strong.
Ryan Severino from BGO commented on this trend saying that it is rare for major disruptions or collapses within the banking system as many may fear. This has been true last year as well as this year so far according to Severino who said: “We didn’t think that would be case last year; we don’t believe it will be case this.”
The Pinpricks
A report released by The Federal Reserve’s Dodd-Frank Act Stress Test 2024 showed concerns over larger banks potentially experiencing substantial losses under severe economic downturns while maintaining required regulatory levels for common equity tier one capital ratios above minimum requirements.
Jonathan O’Kane from Chandan Economics delved deeper into these concerns explaining how commercial real estate debt on financial institution balance sheets has increased significantly since 2014 reaching approximately $3 trillion at end of December 31st ,23 . He also noted how Trepp, Inc. estimated that around 30% of this debt is expected to mature by 2026, making real estate and banking-sector stress the third and fourth most significant risks to the U.S. financial system according to The Fed’s latest report.
Stephen Buschenbom from Trepp, Inc. also expressed concerns about deteriorating loan performance due to elevated interest rates: “there’s going be still more pain come from deteriorating loan performance particularly for commercial real estate.”
While larger banks have increased their cash reserves (known as loan-loss provisions) in preparation for potential losses from default loans, smaller regional and community banks have not done so at the same level.
Eric Enloe from Valuation Advisors acknowledged that while there is more diversity in banking exposure towards office assets these days; there are still concerns over potential defaults on office loans: “we haven’t really started address pain in office sector which unlikely reverse itself even with easing interest rates.” He added how value degradation within this sector has been a result of shifting demand dynamics over past five years.
What To Expect
The future outlook for the banking industry remains uncertain as experts predict multiple challenges ahead.
Ray Perryman , President of The Perryman Group believes widespread meltdown is unlikely despite vulnerabilities such as exposure towards interest rate changes or upcoming debt maturities stating that most banks have sufficiently diversified their risk profiles.
Jonathan O’Kane was less optimistic noting how conditions are present for industry distress but it’s difficult gauge whether they will lead another crisis or not .
Ryan Severino pointed out how smaller regional banks struggle with problematic loans on balance sheets leading negative selection bias phenomenon . This has resulted lower-quality collateral and less portfolio diversification . However he noted reforms implemented last year held up well .
Omar Eltorai , Director Research Altus Group anticipates significant changes coming one three years especially among smallersized institutions who may face corporate consolidations due challenging operating environment combined trapped capital portfolios . “These consolidations will stem from a challenging operating environment, combined with trapped capital in their loan portfolios,” Eltorai said.
