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  • Writer's pictureRealFacts Editorial Team

Bank Delinquency Rates Eke Up, Negative Pressure from High Interest Rates to Continue


Bank

The June 2024 FOMC meeting has left the commercial real estate (CRE) industry in a state of anticipation, waiting for a clear signal of monetary policy easing. Lower interest rates could alleviate the negative pressure on property values, net income, lending, transaction volume, and loan delinquency rates. Since the radical jump in interest rates began in 2022, CRE capital markets have faced significant turmoil. Surprisingly, the rise in bank delinquency rates for CRE loans has been relatively mild so far, though this trend is expected to worsen, especially for maturing loans and those backed by assets with stagnant or declining net cash flow.


Interest Rates and Inflation


The Federal Reserve's decision to maintain the target Fed Funds Rate range at 5.25-5.50% reflects a continued hawkish stance amid persistent inflation. As of June 21, the Core CPI stood at 3.3%, down from 5.3% a year earlier but still above the Fed's 2-2.5% target. The Fed must balance the risk of rampant inflation reemerging against the potential stress on financial capital markets, including CRE, which could spill over into the broader economy.


The Importance of Monitoring Banks' CRE Portfolios


Since the failure of banks like SVB in the spring of 2023, there has been heightened scrutiny on the health of banks and potential financial system contagion, particularly concerning their CRE loan concentrations. Despite concerns, banks generally face serious trouble only if they have a host of other risks in addition to significant exposure to specific types of CRE loans.



Graph of banks multifamily debt

Banks are the largest holders of US CRE mortgage debt, accounting for 38% or $1.8 trillion of the $4.7 trillion in outstanding CRE loans. This makes it crucial to monitor their CRE portfolios for systemic financial risks.


Distribution of CRE Mortgages


CRE mortgages are roughly evenly distributed among the largest banks, regional banks, and community/small banks. Banks' share of US CRE debt has remained steady over the past year, with a slight increase of 2.5%. Most of the growth in outstanding loans was among community banks, which expanded by nearly $40 billion or 9%, driven by smaller office deals.


The concentration of CRE loans as a share of total assets varies significantly among banks. For the largest 25 US banks, direct CRE lending averages 4.3% of total assets, unchanged from a year prior. Regional banks saw a slight increase from 16.5% to 17.5%, while community banks have the highest concentration, with 25.7% of assets in CRE loans, up from 24.3% last year.


While the overall exposure to CRE is moderate, the degree of risk varies widely among individual banks. The focus now is on which banks are most at risk from CRE loans rather than which banks might trigger a financial system crash due to CRE.


Rising Delinquency Rates


Delinquency rates for bank CRE loans have been increasing over the past few quarters and will continue to rise through the first quarter of 2024. With no imminent relief from high interest rates, delinquencies are expected to keep climbing this year. Over $900 billion in CRE loans are set to mature in 2024, nearly half of which are held by banks. Many of these loans, particularly office loans, will struggle to pay off as scheduled.


Delinquencies by Bank Size


Data from the FDIC reveals that delinquency rates and net charge-offs among banks are rising, especially for large banks with substantial commercial loans. As of Q1 2024, the delinquency rate for commercial loans held by the largest banks was just over 3%, while the net charge-off rate was 0.84%. Larger banks are under more stringent regulatory pressure and capital requirements and hold a majority of large office loans, which have struggled to find refinancing.


Graphs of net charge-offs and delinquencies among banks


There is also a developing trend of rising multifamily delinquencies and net charge-offs, although these rates remain low by historical standards. Multifamily loans held by the smallest banks (<$100 million in assets) show higher delinquency rates, likely due to lower regulatory oversight and the idiosyncratic nature of small properties and borrowers.


Overall, the trend of rising bank CRE loan delinquencies is concerning but remains moderate. Within each bank category, there is a wide dispersion of loan performance, indicating that some banks are more at risk than others. As this business cycle progresses, monitoring non-performing CRE loans and charge-offs will be crucial to understanding the broader financial implications.

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