When CRE hits investors, fine, they were paid to take those risks. But we’re a little more squeamish when it comes to banks.

Commercial Real Estate loans amount to about $5 trillion. Not all CRE sectors are in trouble. At one end of the spectrum: Industrial is still in good shape. At the other end of the spectrum: office is in terrible shape. Somewhere in the middle: There have been some big defaults in multifamily, but the sector is in much better shape than office.

The 4,026 or so FDIC-insured commercial banks held $2.4 trillion of CRE loans at the end of 2023, according to FDIC data, amounting to roughly 10% of their total assets of $23.7 trillion. So banks hold a little less than half of CRE loans, and those loans are about 10% of their total assets.

The remaining CRE debt is held by investors via commercial mortgage-backed securities (CMBS), collateralized loan obligations (CLOs), mortgage REITs, PE firms, insurance companies, pension funds, foreign banks that piled into US CRE, and a big portion is held by US taxpayers who are on the hook for 55% of the $2 trillion in multifamily CRE loans. We’ve discussed this debacle for investors over the past two years, and we’ve documented numerous massive blowups that left us with the suspicion that banks securitized the riskiest and worst CRE loans and sold the CMBS to investors.

When CRE losses hit investors, fine, they were paid interest to take those risks, so it didn’t work out, and OK. Everyone acknowledges this risk was part of the deal.

But everyone gets squeamish when it comes to the banks because they’re like financial utilities for the economy, and they’re all tightly woven together into the US banking system, making it fertile grounds for contagion, and they’re by nature risky utilities (they borrow short and lend long). Three regional banks collapsed in 2023, but none of them because of bad CRE loans – or bad loans of any type. Another one was forced to self-liquidate and didn’t require FDIC deposit insurance. In addition, two tiny banks collapsed without making any ripples.

Banks’ exposure to CRE as % of their loan book, by size of bank.

A higher percentage means banks are specialized in CRE loans and are more heavily exposed to CRE problems. A lower percentage means banks hold many other types of loans, and CRE is only a small part of their total loan book (CRE loan data via Lipper Alpha):

Large banks: 6% of their loans are CRE loans. Each of these banks has over $250 billion in assets. There are only 14 of them, and they hold 56% of total banking assets. It’s those few big banks that matter to the financial system. If one of them fails, it can shake things up. If several fail, it’ll rattle a lot of nerves. On average, only 6% of their loans are CRE loans. If they take big losses on their CRE loans, it will dent their earnings and hurt their stocks, but CRE losses alone won’t topple the bank; they would have to have big other issues.

Mid-size banks: 17% of their loans are CRE loans.  These banks have between $10 billion and $250 billion in assets. There are 121 of these banks, 16 of them have over $100 billion in assets. If several of those bigger 16 topple, there would be some ripples across the financial system.  And we would notice it and write about it.

Small banks: 31% of their loans are CRE loans. These banks have between $1 billion to $10 billion in assets. There are about 700 of these banks. 31% of the loan book being CRE is huge exposure – with some banks being more exposed and others less exposed. CRE losses will likely pull the rug out from under some of those small banks over the next few years. And we’ll notice, but we’ll probably not write about it.

Tiny banks: 28% of their loans are CRE loans. These banks have between $100 million and $1 billion in assets. As a group, they’re hugely exposed to CRE, and there are thousands of those banks, and some of them, maybe dozens of them, will fail over the next few years. But these bank failures won’t even make ripples across the financial system. Locals will notice, they will lose perhaps the only bank in their small town, and that’s a problem for the town, but it’s not a problem for the financial system. If such a tiny bank fails, we won’t write about it just like we didn’t write about the two tiny banks that failed in 2023.

To the overall banking system, it doesn’t really matter if 50 tiny banks collapse, of the 4,026 commercial banks in the US, most of which are tiny banks. The big banks do matter, but they’re much less exposed to CRE. As their CRE loans go sour, they dent earnings and whack down stocks, but CRE alone won’t pull the rug out from under those big banks.

©WolfStreet