About two dozen banks in the US had portfolios of commercial real estate loans in late 2023 that federal regulators indicated would merit greater scrutiny, a sign more lenders may face pressure from authorities to bolster reserves.

A trio of regulators publicly warned the industry last year to carefully assess any large exposures to debt on office buildings, retail storefronts and other commercial properties. At the time, authorities said they would pay closer attention to banks that rapidly piled up such loans worth more than three times their total capital.

While New York Community Bancorp, which set off a cascade of stock drops in recent weeks as it braced for potential loan losses, was the biggest US bank that came close to fitting the regulators’ criteria, many smaller lenders went further. That’s because they amassed outsize concentrations even faster, according to a Bloomberg analysis of federal data from more than 350 bank holding companies.

The three watchdogs — the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency — indicated they would focus on banks whose portfolios of commercial real estate loans are more than triple their capital. Within that pool, examiners would zero in on portfolios that had grown dramatically: at least 50% in the past three years.

Firms whose loans crossed both thresholds as of Sept. 30 include Valley National Bancorp, WaFd Inc. and  Axos Financial Inc., the data show. Shares of those regional banks and many others have declined since late January as investors grew wary of commercial-property exposures, partly because of the prospect that regulators might press some lenders to bolster reserves or curb dividends.

Whether authorities take additional such action will hinge on a closer examination of loans.

“We’re at the warning stage,” said Keith Noreika, who was acting comptroller of the currency in 2017. “There’s a light going off on the dashboard and now people are opening up the hood to see: Is it really wrong or do we just need to keep our eye on it?”

To be sure, regulators won’t limit their scrutiny to banks that cross those thresholds, nor will firms that do so necessarily set off further concerns. The performance of loans can vary widely.

“It's important to have a good dialogue with your regulators, have them understand what goes on. So we feel we have a really good dialog and not much concern,” Valley National Chief Executive Officer Ira Robbins said in a Bloomberg Television interview Thursday. “Look, the regulator has to do their job and understand what's going on in the market. And if there's heightened concern — scrutiny — associated with a specific segment, they're definitely coming in and spending more time looking at that. But I don't think it's anything out of the ordinary versus what would've happened if there was more concern within another sector.”

WaFd said it deliberately expanded financing of occupied — or in industry parlance, stabilized — multifamily buildings.

“Stabilized multifamily loans are the lowest-risk loans we as a bank can make, according to both our own historical experience and also FDIC industry data,” CEO  Brent Beardall said in an emailed statement. Loans in the portfolio have significant equity — typically 40% — and diversified cash flows, he said. “One never knows what the future will hold but, it is hard to ignore the strength of lending with multifamily collateral.”

Spokespeople for the three regulators, New York Community Bancorp and Axos declined to comment or didn’t respond to messages.

“There's some smaller and regional banks that have concentrated exposures in these areas that are challenged, and you know we're working with them,” Fed Chair Jerome Powell said in a 60 Minutes interview this month. “It feels like a problem we’ll be working on for years.”

Merger Math
Bank mergers can dramatically affect growth rates reflected in banks’ Fed filings, yet the public guidance regulators issued last year doesn’t specify how they may view that math. Umpqua Bank’s reverse merger into Columbia Banking System Inc., for example, left Columbia as the parent company — and on that basis its commercial property portfolio swelled more than 500%, lifting it off the chart above. If Umpqua were the parent, the growth rate would be closer to 70%.

Using pro-forma figures that combine a pair of banks’ numbers before and after a merger generally lowers their growth rate below 50%. However, regulators have said one reason they focus on rapidly expanding commercial-property portfolios is that they want to give credit to management teams that have many years of experience dealing with large piles of the loans. Assembling portfolios slowly also gives executives more time to spot and avoid concentration risks.

New York Community Bancorp is the only US lender with more than $100 billion of total assets with commercial real estate loans amounting to more than 300% of capital at the end of September. Its portfolio grew slower than the threshold set by regulators, even including the bank’s acquisition of Flagstar Bank, completed in late 2022.

Bloomberg’s review found 22 banks with $10 billion to $100 billion of assets hold commercial property loans three times greater than their capital. Half of those firms had growth rates surpassing the thresholds laid out by regulators. The tally was even higher among banks with less than $10 billion of assets: 47 had outsize portfolios, of which 13 had swelled rapidly. The analysis excludes loans for nonresidential buildings that are occupied by their owners.

Banks are starting to disclose figures for the end of 2023. BCI Financial Group Inc., the parent of City National Bank of Florida, said that by Dec. 31 the unit’s commercial-property concentration was “within regulatory guidance” at 299% of capital.

“CNB’s loan portfolio is well diversified and well positioned, with a low loan-to-value ratio and a primary concentration in the state of Florida, which is supported by a strong economy that is outperforming the rest of the US,” the company said in a statement.

Bank exposure to commercial real estate shot into focus for investors after NYCB surprised shareholders in late January by slashing its dividend and bolstering reserves for troubled loans. The moves followed mounting behind-the-scenes pressure from the OCC, Bloomberg later reported.

Investors are watching for fallout at lenders as heightened interest rates drive down commercial-property values. Much of that pain is concentrated in office towers after the pandemic ushered in remote work. But apartments that were financed at peak prices a few years ago have also seen values drop, sometimes hurt further by local efforts to rein in rents.

Even the largest property owners — from Blackstone Inc. to Brookfield Asset Management Ltd. — are defaulting on some debts. Other landlords are cutting their losses and walking away from buildings.

For a few years, banks had leeway in marking down commercial-property loans because values were hazy, with heightened interest rates freezing swaths of the market. That also gave lenders more flexibility to extend debts and strike deals with borrowers. But it gets trickier as the drop in commercial-property prices becomes clearer.

Now, with the Fed signaling a slow approach to lowering rates, more property transactions are starting to shed light on what buildings are worth just as a wave of outstanding loans near maturity. Banks are facing roughly $560 billion of commercial-property loan maturities by the end of 2025, according to commercial real estate data provider Trepp.

Lenders seeking to reduce their exposure to commercial real estate face a tough market for loan sales. Some, such as Capital One Financial Corp., have found buyers. But for offices and other risky properties, it hasn’t been easy to find investors to take on loans.

Predictions for how the situation will play out are difficult, because loans are idiosyncratic and can’t be “painted with a broad brush,” Noreika said. “It’s sort of one of those things that’s not a problem until it’s a problem.”

This article was provided by Bloomberg News.