Why S&P Cut Outlook for Five US Regional Banks With Heavy Commercial Real Estate Exposure

Five smaller U.S. banks with exposure to commercial real estate have been hit with credit-rating outlook downgrades, the latest development threatening to make borrowing more difficult for businesses and individuals.

S&P Global Ratings downgraded its ratings outlook on five regional lenders late Tuesday to “negative” from “stable,” while affirming their ratings. The five are First Commonwealth Financial Corp. (FCF), M&T Bank Corp. (MTB) , Synovus Financial Corp. (SNV), Trustmark Corp. (TRMK), and Valley National Bancorp (VLY).

The ratings agency said the five were among the most exposed to commercial real estate in its coverage and that the downgrades reflect the possibility that stress in the sector could hurt the asset quality and performance of these regional banks. Loans on investor-owned commercial real estate, multifamily, and construction and development properties made up between roughly 25% and 55% of the these banks’ lending as of the end of 2023.

Commercial real estate has been hit by lower prices and higher vacancies as workers continue to shun the commute to the office after the pandemic.

“Most of these banks also have higher-than-peer exposures to loans on office properties, which we generally consider to be the riskiest part of CRE lending because of the secular shift in work-at-home arrangements and often sharply reduced property prices,” S&P Global said, noting however, than none of the five has so far recorded sharp rises in delinquent and non-accrual lending and all have maintained conservative lending standards when doling out funds.

The ratings agency said that while cuts in interest rates by the Federal Reserve could alleviate some of the stress in commercial real estate and reduce the risk of a rush of soured loans, “higher-for-longer” interest rates pose a risk.

In a note out Wednesday, Wedbush Securities analysts said they remain cautious on the overall banking sector as the outlook for interest rates “leans higher for longer.”

“Banks with larger consumer and commercial real estate portfolios, especially office and rent-regulated multifamily, may see above-average increases in credit costs,” it added.

S&P said it now has negative outlooks due to sizable commercial-real estate exposure on nine of the U.S. banks—or 18% of the lenders—it rates. 

Smaller U.S. banks have a higher portion of their loan portfolios in commercial real estate than do their larger counterparts, a point that came into sharp relief earlier this year when New York Community Bancorp Inc. (NYCB) reported a surprise quarterly loss  and made a series of disclosures about problems with real estate loans and lapses in internal controls that dragged the shares of most of its peers lower.

The SPDR S&P Regional Banking exchange-traded fund (ETF) (KRE), a broad gauge of the sector, is down almost 3% so far this year, as of Wednesday afternoon trading.