FDIC Increasingly Concerned About CRE Loans That are Falling Behind

The third quarter saw a significant increase in the number of noncurrent bank loans, according to the Federal Deposit Insurance Corporation’s Quarterly Banking Profile for Q3 2023.

“Looking more closely at commercial real estate portfolios, we are beginning to see concerning trends in non–owner–occupied property loans,” said FDIC Chairman Martin Gruenberg in prepared remarks. “The volume of noncurrent non–owner occupied CRE loans increased by $4.1 billion, or 36.4 percent, quarter over quarter. In addition, these loans had a noncurrent rate of 1.31 percent in the third quarter, up from 0.96 percent last quarter and 0.54 percent a year ago. This is the highest noncurrent rate reported for this loan portfolio since third quarter 2014.”

These trends are being driven primarily by deterioration in office loans, according to the agency.

The aggregate net income from the 4,614 FDIC-insured banks and savings institutions during the quarter was $68.4 billion, down 3.4% from the second quarter. The first two quarters “benefited from non-recurring accounting gains resulting from the acquisition of the three large bank failures this spring.” Without those, net income would have been relatively flat. Year over year, net income was down 4.6%, which means less perceived ability to manage concerns about the viability of assets like CRE loans.

There are also other factors that compound the potential concerns of depositors. “Unrealized losses on available–for–sale and held–to–maturity securities increased to $683.9 billion in the third quarter,” Gruenberg wrote. “Higher market interest rates and mortgage rates caused market values for debt to decline during the quarter. Though the U.S. economy has remained strong in 2023, the banking industry still faces significant downside risks from the continued effects of inflation, rising market interest rates, and geopolitical uncertainty. These issues could cause credit quality, earnings, and liquidity challenges for the industry. These issues, together with funding and earnings pressures, will remain matters of ongoing supervisory attention by the FDIC.”

Another aspect of banking business models, which are tied closely to the ability to lend to CRE companies, is a reversal of a balance between loan yields and deposit costs. When interest rates started to rise, yields grew faster than deposit costs. In the first three quarters of 2023, however, “loan yields have increased more in line with deposit costs, and deposit costs outpaced loan yields by three basis points in the third quarter.” And banks have shifted from lower–yielding deposit accounts to higher–yielding time deposits, which is more expensive for them. The trend has continued through the third quarter, but non–deposit liability costs, up “substantially” last quarter, were flat this one, “helping the industry to improve its net interest margin modestly.”

The bulk of all this is increased pressure on banks to keep depositors and regulators happy, which means keeping a close eye on assets that might become troubled, like CRE loans.