Concerns Over CRE Lending Remain for the Fed

In particular, the bank consumer and CRE lending divisions are under close observation by the Fed for possible signs of credit deterioration.

The November 2023 Supervision and Regulation Report states that the Federal Reserve Board of Governors has stated that there are issues even if they believe the “banking sector remains sound overall.” The lending of banks to commercial real estate was one of the problematic areas they identified. Overall, the banking sector is still solid. According to their writing, banking institutions “continue to report capital and liquidity levels above regulatory minimums.” Despite recent pressure on net interest margins, earnings performance has remained strong and consistent with pre-pandemic levels. The decrease in deposits caused by the financial strains in March has abated. Overall, loan delinquency rates continue to be low.

Yet, banks have raised credit loss provisions, and delinquencies for CRE and certain consumer sectors have risen from their low levels. Some banks continue to face elevated liquidity and interest rate concerns, which can be partly related to rising funding costs and large fair-value losses on investment securities. While not the primary problem, CRE is significant enough to be mentioned separately. Delinquency rates for consumer and real estate loans, which “increased slightly during the first half of 2023,” were one culprit, according to the report. It’s hardly shocking that “the CRE office loan segment showed the largest increase in delinquency rates for the largest firms.”

According to the report, S&P and Moody’s have downgraded the bank sector’s credit rating. They both mentioned CRE exposure and rising interest rates, which have caused some banks’ long-term bond holdings to significantly lose value. The Federal Reserve noted that although loan delinquencies are low, larger banks are building up their reserves to protect themselves from lending losses. But that’s not all that’s happening. While larger banks become more cautious and hoard more cash, they are decreasing lending, while smaller banks are increasing their CRE credit activity. Despite the fact that the Fed’s research focuses mostly on large banks, those are the organizations with the resources to more readily endure an issue with CRE loans.

According to estimates, the $33 billion CRE loan portfolio held by Signature Bank would see a fire sale, driving values 15%–40% below face value. In an era of constrained price discovery, this kind of outcome would probably impact loans and property assessments in general. Between 2024 and 2026, waves of maturing office loans are also expected in significant markets. Delinquency rates for CRE bank loans have already reached a 10-year high.
“They wrote that some firms, particularly in the office segment of CRE, have indicated in public earnings releases that they expect increased loan losses.” Supervisors thus keep a careful eye on loan quality and underwriting. A horizontal review has been conducted recently to mitigate exposures to possible declines in CRE markets.

In the end, tighter banking regulations affect all banks, larger ones more so since they attract more attention, but smaller ones eventually close out of prudence or in the event that things go wrong. Recall that following the Global Financial Crisis in 2010, 155 banks closed. 530 closed in 1989 following the savings and loan crisis of the 1980s. There is a chance that banks may become less willing to take on CRE loans, and there isn’t likely to be enough nonbank lending to make up for it, especially because federal regulators are currently preparing to increase their level of oversight of them as well.

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