Clouds rising over banks? As interest rates stay high, FAU survey handicaps risks for lenders with big books of commercial loans

The size of the construction loan is as stunning as the Miami super tall structure it’s helping to build.

The recently announced $688 million financing for the Waldorf Astoria Hotel & Residences, scheduled to rise 1,049 feet above Miami’s downtown on Biscayne Boulevard, is courtesy of Bank OZK of Arkansas and Related Fund Management.

But the building’s wow quotient  — it would be the tallest residential structure south of New York — is less of a factor for a Florida Atlantic University finance professor who is more concerned with the cumulative lending portfolios of Bank OTZ and scores of other banks across the nation that maintain large books of commercial real estate loans in a high-interest rate economy. Borrowers took out many of those loans several years ago, and many are scheduled to come due in 2025 and 2026. If any are to be refinanced, the borrowers will have to pay higher interest rates.

Rebel Cole surveyed the commercial real estate lending exposures of 157 U.S. banks with at least $10 billion in assets and concluded “more than 60 of the largest banks in the country are at increased risk of failure due to their commercial real estate (CRE) exposures.”

“This is a very serious development for our banking system as commercial real estate loans are repricing in a high interest-rate environment,” he said in a statement. “With commercial properties selling at serious discounts in the current market, banks eventually are going to be forced by regulators to write down those exposures.”

At substantial fees, some banks have taken to buying credit insurance from investors who essentially take over some of the loan risk from the institutions, the Wall Street Journal reported this week.

Using public quarterly data from the Federal Financial Institutions Examination Council Central Data Repository, the FAU survey lays out each bank’s total exposure level as a percentage of the institution’s total equity. “Bank regulators view any ratio over 300% as excess exposure to CRE, which puts the bank at greater risk of failure,” Cole said in a statement that accompanied the survey’s release earlier this month.

Bank OZK, formerly known as Bank of the Ozarks, has become known in financial and development circles as the most aggressive lender in Florida for condos and other types of commercial projects elsewhere in the U.S. The FAU survey placed its loan exposure level versus equity at 620.5%, ranking it No. 2 on the list. Dime Community Bank of New York tops the list at 653.7%.

Bank OZK did not respond to an emailed inquiry about the FAU survey’s conclusions. The bank’s financing of the Miami super-tall alone is not problematic in the eyes of analysts — 90% of the project’s 307 condo units are reportedly sold.  But securities analysts at two Wall Street firms including Citigroup have downgraded the institution’s stock to “sell,” citing the bank’s overall exposure to commercial real estate.

Two Florida banks occupy the FAU list with ratios above 300% — City National Bank of Florida ranked No. 23 at 438.7% and SouthState Bank of Winter Haven was ranked No. 56 at 320.5%.

City National, in a statement, called the FAU survey “incorrect.”

“City National Bank’s commercial real estate concentration is within regulatory guidance and below the risk threshold established by the Office of the Comptroller of the Currency,” the bank said, adding that its commercial real estate portfolio “continues to outperform industry averages.”

The bank cited several metrics to demonstrate the soundness of its loan portfolio. They include loan-to-value ratio, which compares the amount of a loan to the value of an asset being purchased (in City National’s case it’s 50%), a debt service coverage ratio where net operating income is a healthy 1.8 times the debt, and non-accruals, which relates to unsecured loans where borrowers haven’t made a payment for 90 days or more, at a miniscule 0.4% of the portfolio.

“These metrics are the result of CNB’s disciplined credit process and sharp focus on relationship banking within Florida — the strongest commercial real estate market in the U.S,” the bank said.

SouthState did not respond to an emailed request for comment.

Three other in-state banks were below the survey’s 300% loan to equity measure — Seacoast National Bank of Jupiter was No. 90 at 251.%; Everbank of Jacksonville, ranked at No. 103, was at 186.5%; and Raymond James Bank of St. Petersburg stood at No. 111 with a 142.3% ratio.

In a statement, Seacoast Chairman and CEO Chuck Shaffer said the bank “intentionally maintains a very conservative risk posture and, as FAU’s analysis found, has less exposure to commercial real estate (CRE) mortgages than most other banks. Our commitment to maintaining some of the highest capital levels in the banking industry is reflected in our 14.6% Tier 1 capital ratio, ranking Seacoast Bank among the nation’s top 10% strongest banks.

“Seacoast Bank’s exposure to commercial real estate is relatively low,” Shaffer added. “According to the regulatory definition, our CRE exposure is equal to 221% of our regulatory capital, well below the 300% threshold that FAU considers as high exposure to CRE mortgages. Furthermore, our diversified lending strategy across various asset classes, industries, and loan types ensures a broad exposure distribution, which has been instrumental in managing risk.”

He added that the institution’s conservative balance sheet principles has “positioned it to serve customers and communities through any economic cycle with strong asset quality that reaffirms our high credit standards.”

The bank does not lend to large office buildings in downtown business districts and its commercial real estate exposure “is largely within Florida, which continues to see much stronger performance than many other geographies across the country.”

Another bank, Everbank, said it had no comment.

In an interview, Cole asserted that the chief problem facing the industry is that trillions of dollars in commercial  real estate loans that originated 2018 and 2019 will start rolling over this year at higher costs due to rising interest rates pushed by inflation.

“When that stuff has to be refinanced, you are looking at borrowers who are going from a 3% mortgage to a 6% or 7% mortgage,” Cole said. “You are going to see some of the borrowers just hand the keys to the banks.”

The banks, in turn, will sell the properties, or try. Many will go at discount prices and drag down the market.

“It’s just like the first couple of pebbles that hit the water — the ripples are just starting,” he said.

Cole acknowledged that the current health of banks in Florida “is quite good.”

“But there is a tsunami coming and you had better be running inland,” he said. “That means getting some of that real estate off their books.”

Interest rate conundrum

“There’s definitely a lot of pressure on lenders,” said Brett Forman of Forman Capital in Boynton Beach. “The interest rates definitely are a big factor … it’s been an unknown.”

That’s mainly attributable to a Federal Reserve that hinted at rate cuts this year, only to hold back. “If rates stay stagnant this year without any cuts, it just furthers the horizon for a correction,” he said.

“Even if interest rates start trickling down sooner or later there has to be a buyer for the [troubled] asset or another lender,” he said. “And if that means you can’t get the entire loan repaid through a refinancer ,,, what happens? Does someone put up more equity? Does the bank have to start a foreclosure?

Florida more resilient

Investors and industry service professionals point out that the commercial real estate picture in Florida is in better shape than in the Northeast, Midwest and elsewhere around the nation  in the wake of COVID-driven arrivals of new residents and businesses from out of state.

“Florida is going to be a little more protected than other markets,” said Anthony Scavo, chief operating officer of Basis Industrial, a real estate operator-developer with offices in Boca Raton.

“There’s a lot of buyers in Florida,” he said. “I think there is a lot of money sitting on the sidelines now.”

Miami attorney Daniel Diaz Layva, chair of the real estate practice at Day Pitney, called South Florida and Florida “uniquely positioned.” versus elsewhere in the country.

“Not all markets are equal,” he said. “We are already seeing distress in some markets. Owners are handing over the keys to primarily office buildings in markets like New York and San Francisco. Those markets obviously are challenged, to say the least.”

“We continue to see population growth [in South Florida], albeit a little lower than immediately after the COVID pandemic,” he said. “The cadence is consistent and strong compared to other markets, and that will sustain us through these challenging times.”

Forman said that even if the banks have to take back certain properties, “the values are higher in certain parts of Florida given the increase in [population] density and demand coming out of COVID.

Meanwhile, banks “have somewhat pumped the breaks on commercial lending” and non-bank lenders have helped fill the void for borrowers seeking financing, said Diaz Layva.

“Obviously there will be challenges,” Diaz Layva added. “But I would much rather be sitting in Florida than in Kansas.”