Recent Trends in Banks’ Commercial Real Estate Exposure

Due to societal and economic changes triggered by the COVID-19 pandemic, segments of the commercial real estate (CRE) sector have increasingly become the focus of policymakers and analysts concerned with financial stability. More specifically, the shift to work from home has challenged the office segment, while changes in retail trade—such as a ramp up in e-commerce—have prompted a negative outlook for property segments like suburban shopping malls. These negative trends in property value fundamentals may eventually trigger delinquencies and defaults on the debt backed by these types of assets.

In previous research, we showed that almost 40% of CRE-backed debt is held by U.S. banks. Additionally, our last blog post showed that a measure of exposure to assets backed by CRE seemed to be negatively correlated with the stock market value of different U.S. bank holding companies (BHCs) in recent years, whereas no such correlation existed in the past. In this blog post, we study some recent trends in U.S. BHCs’ exposure to CRE.

Recent Trends in CRE Exposure

The figure below plots the distribution of CRE exposure as a percentage of BHC total assets from the first quarter of 2011 to the first quarter of 2024, the latest quarter of available data. Our measure of CRE exposure is constructed using individual BHC data from quarterly regulatory reports (FR Y-9C) and accounts not just for direct exposure to CRE (i.e., loans backed by CRE that are directly held by banks) but also for indirect exposure vis-à-vis securities (i.e., commercial mortgage-backed securities) and off-balance sheet exposure (i.e., commitments to fund CRE loans). We then sorted those banks’ CRE exposure by percentiles, with a higher percentile implying more CRE exposure. The solid line denotes the exposure held by the median bank; the darker-shaded area corresponds to the 25th to 75th percentile range; and the lighter-shaded area represents the 10th to 90th percentile range.

BHCs’ Exposure to CRE Varies by Business Model and Time Period

SOURCES: Federal Reserve (FR Y-9C data) and authors’ calculations.

The figure shows there is significant variation in terms of CRE exposure, reflecting different business models: Some BHCs have exposure that exceeds half of the total value of their assets, while others have relatively low exposure (i.e., less than 10% of their total asset values). CRE is extremely important for the median bank, which had an exposure of 39% as of the first quarter of 2024.

The figure also shows how CRE exposure has varied over time, decreasing around the time of the 2007-09 financial crisis (not shown) before increasing as the economy began to recover.While the crisis was mostly triggered by a downturn in residential real estate, property values were affected across the board, including for commercial real estate. Although exposure decreased at the onset of the COVID-19 crisis in 2020, median exposure has since recovered to slightly above prepandemic levels. It is worth noting that the COVID-19 crisis also coincided with a widening of the distribution of exposure, which suggests that some banks have intentionally reduced their exposures while others have increased them.

The next two figures decompose our measure of CRE exposure into two main components: directly held loans backed by CRE (the second figure) and indirect CRE exposure, mostly in the form of commercial MBS and off-balance sheet exposure (the third figure). Because loans constitute the bulk of total exposure, the overall patterns in terms of time and cross-sectional variation in the first figure below are similar to those in the figure above: an increase in median exposure and a widening of the distribution since the COVID-19 pandemic began.

The third figure shows the evolution of distribution of indirect exposure: Following the financial crisis, indirect exposure across the distribution grew steadily, from a median of 1% in early 2011 to a peak of 6% in the first quarter of 2023. More recently, there has been a decline in this type of holding, with the latest observation for the median being 5%, although its distribution of exposure has also widened.

BHCs with Direct Exposure: Loans Backed by CRE

BHCs with Indirect Exposure: Commercial MBS and Off-Balance Sheet Holdings

SOURCES FOR BOTH FIGURES: Federal Reserve (FR Y-9C data) and authors’ calculations.

Which BHCs Are the Most Exposed to CRE?

One of the observations from the figures above is that the distribution of CRE exposure seems to have widened in recent years, with some banks increasing their exposures while other banks have reduced theirs.

The next four figures shed light on the characteristics of BHCs with the largest CRE exposures as of the first quarter of 2024. Each of these figures presents a scatter plot showing CRE exposure as a percentage of total assets in the y-axis and a measure of relevant bank characteristics in the x-axis, with each point representing a BHC that files the FR Y-9C reporting form.

The figure below (the fourth figure) plots CRE exposures against a measure of BHC size (the natural logarithm of total assets). The figure shows that larger BHCs tend to be less exposed to CRE, consistent with the narrative that a lot of the risk exposure tends to be concentrated in small- and medium-sized BHCs. The correlation between the two variables is -0.43.

Larger BHCs Tend to Be Less Exposed to CRE as of 2024:Q1

SOURCES: Federal Reserve (FR Y-9C data) and authors’ calculations.

NOTE: The dashed line is the regression line, and the shaded area represents the area bounded by a 95% confidence interval.

The next figures (fifth and sixth figures) plot CRE exposures against two common measures of bank business models:

• Banks with more traditional business models tend to hold mostly loans as assets (as opposed to securities) and rely on deposits for funding (as opposed to market instruments and other types of wholesale funding). BHCs with more traditional business models on the asset side—i.e., more loans as a share of assets (fifth figure)—tend to have larger exposures to CRE. Specifically, the correlation between these variables is 0.49.
• Similarly, banks with more traditional business models on the liability side—i.e., banks that rely on deposits as a more important source of funding (sixth figure)—tend to be more exposed to CRE, with the correlation of this relationship being 0.58.

Note that these correlations are partly explained by size, as smaller banks tend to have more traditional business models.

Traditional BHCs with More Loans Tend to Have Greater CRE Exposure as of 2024:Q1

SOURCES: Federal Reserve (FR Y-9C data) and authors’ calculations.

NOTE: The dashed line is the regression line, and the shaded area represents the area bounded by a 95% confidence interval.

Traditional BHCs That Rely on Deposits for Funding Tend to Be More Exposed to CRE as of 2024:Q1

SOURCES: Federal Reserve (FR Y-9C data) and authors’ calculations.

NOTES: The dashed line is the regression line, and the shaded area represents the area bounded by a 95% confidence interval. Due to the regression coefficient, the regression line goes below 0% on the y-axis. In practice, it would be impossible to have negative CRE exposure as a share of assets in our measure.

Finally, the next figure below plots the correlation between CRE exposures and the Tier 1 capital ratio, a regulatory bank leverage metric that measures how much capital BHCs hold to withstand losses on their portfolios. The figure shows a negative correlation, -0.43, between CRE exposures and Tier 1 ratios, suggesting that BHCs with larger exposures tend to be more leveraged. This means that the very same BHCs that are more exposed to CRE are the ones holding less in capital reserves and would therefore be more likely to become noncompliant in case of large fluctuations in the value of their assets.

BHCs with Larger CRE Exposures Tend to Be More Leveraged

SOURCES: Federal Reserve (FR Y-9C data) and authors’ calculations.

Conclusion

Banks’ relative exposures to CRE (as a share of assets) have increased in recent years, especially during the period after the financial crisis. Since the start of the COVID-19 pandemic, there has been an increase in the dispersion of these exposures, with some banks reducing their exposures and other banks increasing theirs. A significant component of reduced exposure has been vis-à-vis indirect exposure, i.e. holdings of commercial MBS and off-balance sheet commitments.

Most of the banks with high relative exposure to commercial real estate as of the first quarter of 2024 were small to medium in size and tended to operate under traditional, or more leveraged, business models. The concentration of CRE exposure among smaller banks may be viewed as a positive, however, as it implies that the economy as a whole—and by extension, the financial system—may be better insulated from CRE risks than a simple look at average and aggregate measures would suggest. Still, it is important to monitor this type of risk.

Note

1. While the crisis was mostly triggered by a downturn in residential real estate, property values were affected across the board, including for commercial real estate.