While investors are closely monitoring banks’ commercial real estate risks because of higher interest rates and changing work habits, CRE risks can vary substantially across property types and geographic locations, suggesting that aggregate CRE exposure may be a poor measure of risk, economists with the Federal Reserve Bank of Kansas City concluded in a recent bulletin.
The economists noted there currently is a correlation between higher CRE concentrations and lower bank stock returns. However, exposure to CRE risk depends on more than just loan concentration, they wrote. Other key factors include the stringency of the bank’s underwriting, its willingness and ability to monitor existing borrowers, and the capital and loan loss provisions it holds against potential losses. The characteristics and location of the underlying properties matter as well.
“Despite a relatively strong economic outlook, investors continue to closely assess the risks that commercial properties pose to banks, particularly those with sizable loan concentrations,” the economists wrote. “Under closer examination, though, CRE risks are diverse and depend strongly on property type, property characteristics and geographic location. In addition, underwriting standards and loss absorption measures can differ substantially across banks. Thus, broad bank risk measures may not provide a complete picture of the risks CRE loans pose to individual banks.”
