After doomsayers all but assured commercial real estate loans would tank regional banks, a ratings agency has declared that threat overblown.
S&P Global in a recent report said six banks it downgraded last year over heavy commercial real estate exposure “have had only gradual deterioration in CRE asset quality.”
Meanwhile, the lenders, which include New York’s M&T Bank and New Jersey-based Valley National Bancorp, along with Columbia Banking System, First Commonwealth Financial, Synovus Financial and Trustmark, have cut their CRE exposure while boosting loss reserves and capital ratios.
But S&P offered a more optimistic prognosis.
“We think the probability that CRE loans will lead to a material weakening of the creditworthiness of rated banks has declined over the year,” the agency said in the report.
S&P also shifted its outlooks for all six banks to stable from negative. A negative outlook signals a heightened likelihood of a credit rating downgrade in the next year and uncertainty around an institution’s financial health.
A stable outlook suggests a firm is on solid ground.
The updates are a marked shift from last spring when industry bigwigs were screaming that the sky was falling. (The sky being hundreds of regional banks; falling meaning failing.) They pointed to the waves of distress crashing over the country’s office buildings and uncertainty over where the Federal Funds rate might land.
The downturn was a threat to all lenders but regional banks took center stage as they’d taken on the lion’s share of commercial real estate lending after bigger institutions pulled back after the Global Financial Crisis.
According to S&P, the Fed’s 1 percentage point cut has been a help, as have growing deposit bases and signs that property values are stabilizing. That is, the market has found its bottom.
When everyone is clearer on what a building is worth, lenders are more willing to refinance because they have greater certainty around the downside risk. Plus, default rates fall as borrowers have more options to sell.
The moves don’t mean that distress risk is entirely in the rearview. Delinquencies, loan modification and defaults will likely tick up, according to S&P. Anecdotally, it’s clear that higher interest rates continue to cause trouble for sponsors at maturity.
“[But] we expect [the banks] to absorb the associated losses through earnings while retaining profitability,” the report authors wrote.
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