Wall Street is worried about another regional banking crisis

Wall Street is experiencing a case of déjà vu.

It’s been nearly a year since the collapse of three US regional lenders left financial institutions and regulators scrambling to prevent the spread of a banking crisis. Today, investors are worried they’re back on familiar territory.

But while the last crisis was all about interest rate risk, this one revolves around the $20 trillion commercial real estate market.

What’s happening: After decades of growth bolstered by low interest rates and easy credit, commercial real estate has hit a wall.

Office and retail property valuations have been falling since the pandemic changed where people live and work and how they shop. The Fed’s efforts to fight inflation by raising interest rates have also hurt the credit-dependent industry.

That’s bad news for regional banks.

US banks hold about $2.7 trillion in commercial real estate loans. The majority of that, about 80%, according to Goldman Sachs economists, is held by smaller, regional banks — the ones that the US government hasn’t classified as “too big to fail.”

Much of that debt is about to mature, and, in a troubled market, regional banks might have problems collecting on those loans. More than $2.2 trillion will come due between now and the end of 2027, according to data firm Trepp.

Fears were exacerbated last week when New York Community Bancorp (NYCB) reported a surprise loss of $252 million last quarter compared to a $172 million profit in the fourth quarter of 2022. The company also reported $552 million in loan losses, a significant increase from $62 million the prior quarter. The increase was driven partly by expected losses on commercial real estate loans, it said.

Shares of the bank have plummeted nearly 20% over the past five trading sessions and fell an additional 11.2% on Tuesday morning. The US Regional Bank index dropped by about 5.2% over the same period.

Fear also spread overseas. Japan’s Aozora Bank said last week that bad loans tied to US offices were partly to blame for its projected annual loss of 28 billion yen ($190 million) last year.

My colleague Anna Cooban reported last week that Germany’s biggest lender, Deutsche Bank, said it had allocated €123 million ($133 million) during the last quarter to absorb potential defaults on its US commercial real estate loans. That’s more than quadruple the amount it set aside during the same three-month period in 2022.

Some companies are even selling off their once-valuable properties for bargain bin prices. The Canadian Public Pension Investment Board recently sold a 29% stake of an office block in midtown Manhattan to Boston Properties for just $1. The pension fund had invested $71 million in the building.

The Financial Stability Oversight Council, of which Treasury Secretary Janet Yellen, Federal Reserve Chair Jerome Powell and US Securities and Exchange Commission Chair Gary Gensler are members, released a report last December that cited commercial real estate as a major potential financial risk.

“As losses from a [commercial real estate] loan portfolio accumulate, they can spill over into the broader financial system,” they wrote. “Sales of financially distressed properties can reduce market values of nearby properties, lead to a broader downward CRE valuation spiral, and even reduce municipalities’ property tax revenues.”

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