California banks hold the spotlight for outsized property debt

Last year, California was at the center of regional bank turmoil. Now it’s at the front of financial industry exposure to troubled commercial real estate.

Nearly a third of the state’s 127 registered banks have property debt above 300 percent of their capital, the most among U.S. states, according to a Bloomberg, which conducted an analysis of federal call reports that lenders filed for the end of last year.  

Some 31 percent of banks across the Golden State have commercial real estate loans at three times or more of their capital. Other exposed states include New Jersey, at 30 percent; Rhode Island at 29 percent; and Washington at 26 percent.

Banks in Arizona and Alaska, in comparison, trailed at 20 percent, with Massachusetts at 18 percent.

Regulators and investors are eyeballing lenders’ commercial real estate holdings as property values plunge across the nation, mostly for office and apartment buildings.

Last week, Michael Barr, the Federal Reserve’s vice chair for supervision, likened the market’s stress to a “slow-moving train,” according to Bloomberg.

He said the central bank is focused on lenders that have exposure to offices in regions of expected significant price declines.

As the highest interest rates in decades make it difficult for owners to refinance, banks are having to set aside more reserves for troubled loans. Early this year, global firms from New York Community Bancorp to Japan’s Aozora Bank warned of property losses — likely to be in the first-quarter earnings reported this week.

In California, Los Angeles and San Francisco have been hit hard by office-market turmoil stemming from companies shedding offices and the slow return of workers from the pandemic.

Banks’ outsized chunk of real estate loans is partly tied to traditionally high property prices. The vast majority of California’s banks are relatively small, flying under the radar of regulators.

“The financial ecosystem in California is heavily reliant on regional and commercial banks,” Michael Imerman, faculty director of the master of finance program at the University of California at Irvine’s Paul Merage School of Business, told Bloomberg. “Small banks cater to a specific clientele and that can lead to an age-old problem: concentration risk.”

The Federal Reserve, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency have indicated they would closely monitor banks that are within the 300 percent capital pool and have grown their real estate loan holdings by at least 50 percent in a three-year period.

Twenty California banks, or 16 percent of those in the state, exceeded both thresholds — a greater share than anywhere but Washington, D.C., and Oregon, according to the Bloomberg analysis.

San Francisco-based Wells Fargo, with $1.9 trillion in assets, is the only bank headquartered in the state that’s listed as a systemically important financial institution. Regional banks tend to have greater exposure to commercial real estate and lack other businesses, such as investment banking or credit cards, that can spread risk.

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In good times, property loans offer relatively high yields. In bad times, they can magnify losses when values fall, vacancies increase and the cost of financing rises — as is happening now.

“Concentration in anything can kill a bank,” Timothy Coffey, managing director at Janney Montgomery Scott, told Bloomberg.

He said Silicon Valley Bank was felled by its concentration of venture capital and startup clients, while San Francisco-based First Republic Bank focused on high-net-worth people with outsized balances of excess deposits.

“It doesn’t matter what the concentration is,” Coffey said. “That fact it exists is a potential problem for banks and bank regulators.”

— Dana Bartholomew