Commercial Real Estate Can Be a Problem for Banks, and Also a Solution
Summary
- Banks need to do more higher-yielding lending, but be wary of the risks
People are worried about banks’ commercial real-estate lending. They should also be worried about what would happen if they didn’t do it.
Right now, banks are facing a revenue issue. In the first quarter, the yield U.S. lenders earned on what they owned rose more slowly from the fourth quarter than the interest rate they paid to fund those assets, according to the Federal Deposit Insurance Corp.’s updated Quarterly Banking Profile, released this week. That compressed banks’ net interest margin, which is a key measure of their core profitability.
This aligns with what transpired in the first quarter: Many banks were paying a lot more for their deposits, and some even had to switch to more expensive forms of funding, such as from Federal Home Loan Banks. That wouldn’t matter so much if banks were still seeing equivalent or larger jumps in the yields on their loans, which one might think would also be a consequence of rising rates.
Yet a big problem has been that banks parked a disproportionate amount of money during the pandemic in fixed-rate bonds such as Treasurys or mortgage-backed securities. That counterbalanced the natural yield increases banks get on shorter-term or floating-rate lending, such as credit cards.
One thing that does produce a nice yield is commercial real-estate lending. Overall, banks’ earning assets yielded an annualized 4.92% in the first quarter, according to FDIC data. Banks’ real-estate loans, excluding residential single- to four-family homes, yielded 5.4%. That represented a rise of more than 1.7 percentage points over a year earlier. Those residential home-loan yields, by contrast, rose just over 0.6 point from a year earlier, to 3.96%.
Some home loans made at sub-4% yields might not be refinanced or paid down via sale for many years, if ever. Meanwhile, roughly $270 billion of banks’ commercial real-estate lending is set to mature in 2023, according to the data provider Trepp. A maturing loan means a new one can be made, at a higher rate.
But here also lies the problem: Will banks be able to offer new loans to some borrowers at terms that work for both lender and borrower? Some building owners are already walking away from mortgages on properties such as big-city office towers rather than refinancing them, owing to things such as the rising cost of hedging the interest-rate risk of a floating-rate loan, or not wanting to put up more equity to cover for a property’s falling value.
Yet without getting the protection of higher rates or a lot more of an equity cushion against the property value, banks might be wary of the rising risks in areas such as offices, and in some cases, multifamily properties. They don’t want to run straight from a revenue problem into a credit problem.
Noncurrent loans are those that are more than 90 days past due or in “nonaccrual" status, according to the FDIC. The share of banks’ loans that aren’t current, for commercial buildings that aren’t occupied by their owner—in other words, things such as offices that need to be rented out—jumped from 0.56% in the fourth quarter to 0.79% in the first quarter, FDIC figures show. That is still below the nearly 1% rate at the end of 2020. But the jump was far sharper than for other major loan categories.
Banks need to find ways to boost their yields, especially if deposit costs are beginning a lengthy catch-up to higher interest rates. A key question is whether there will be enough creditworthy loans to make.
Write to Telis Demos at Telis.Demos@wsj.com
