Wall Street is worried banks aren’t worried enough about commercial real estate

Regional banks have been setting aside more money to deal with future losses on commercial real estate. Some analysts now fear it hasn’t been enough.

The new worries are surfacing as turmoil surrounding New York Community Bancorp (NYCB) raises concerns about the industry’s exposure to office buildings and apartment complexes that are suddenly worth a lot less due to high interest rates and shifting work patterns.

Analysts are arguing that many other regional banks will likely have to set aside more money this year to absorb future losses from commercial real estate via a balance sheet addition known as “provisions.”

Banks typically add more provisions when they anticipate credit will deteriorate, marking them as an expense. The more provisions banks add, the lower their profits will likely be.

New York Community Bancorp surprised Wall Street last week when it said its provisions had risen to $552 million, up from $62 million in the same year-ago period. It led to a $260 million net loss in the fourth quarter. Its stock has plunged by more than 48% through Monday and was down another 14% in Tuesday morning trading.

“We believe consensus is too low on provision expense for 2024 for nearly every bank we cover,” Manan Gosalia, a regional bank analyst for Morgan Stanley said in a research note Friday.

“I do think that we’re going to see provisions going up across the industry,” added David Chiaverini, a regional bank analyst with Wedbush Securities, in an interview with Yahoo Finance.

What also has investors and analysts concerned is whether regulators could force banks to stockpile more of these reserves.

Bloomberg reported Monday that officials from the Office of the Comptroller of the Currency applied pressure on New York Community Bancorp to set aside more money and slash its dividend in case commercial real estate loans end up souring.

The $116 billion bank has a high level of exposure to rent-controlled apartment complexes in New York City. Those buildings account for 22% of its loans.

New York Community Bancorp said last week that its efforts to build up reserves was an adaptation to stricter capital rules that apply to institutions with more than $100 billion in assets — a threshold it passed last year when it absorbed part of the failed Signature Bank.

Regulators are now “pumping the phones basically asking, ‘What does your commercial book look like?’” Chris Whalen of Whalen Global Advisors told Yahoo Finance.

The concern regulators have, Whalen added, is that higher commercial real estate exposure could get banks “tarred and feathered” by investors.

Acting Comptroller of the Currency, Michael Hsu, testifies on Capitol Hill last May. REUTERS/Evelyn Hockstein/File Photo (Reuters / Reuters)

The stocks of many other regional banks with high exposures to commercial properties are also down over the last week, including New Jersey lender Valley National (VLY).

“What really annoys us about NYCB and other banks with commercial exposures is that they knew months ago that the OCC was demanding pre-emptive increases in capital and loan loss reserves,” Whalen said in a separate research note.

“Why? On the assumption that some commercial property valuations in the $20 trillion market are in a free fall and that, accordingly, defaults will spike in 2024.”

Chiaverini said “the severity of the issue is, I would say, mostly idiosyncratic to New York Community Bank because they were so under-reserved relative to the risk in their portfolio.”

But there is a “perfect storm” that could still create problems for the rest of the industry, according to Chiaverini. If inflation goes back up, forcing the Fed to keep rates higher for longer, and the US economy enters a recession. Borrowers would then have problems keeping up with their loans.

If those things don’t happen, the commercial real estate pain should be “manageable” for the banks, he added.

David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto, and other areas in finance.

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