US banks' exposure to high-volatility commercial real estate loans jumps in Q2

U.S. banks' exposure to riskier commercial real estate loans ticked up in the second quarter to the highest aggregate level in a year.

Regulators define high-volatility commercial real estate ADC loans as credit facilities that provide financing to acquire, develop or improve properties into income-producing ones that are dependent on future income, sales or refinancing of such real properties for repayments.

These exclude one- to four-family residential properties, community development projects, agricultural land, existing income-producing property secured by permanent financings, certain commercial real property projects, real property where the loan has been reclassified as a non-high-volatility commercial real estate ADC loan, and real estate where the loan was made before Jan. 1, 2015.

The rule is not applicable to qualifying community banking organizations that elected to use the community bank leverage ratio framework.

The sector's aggregate balance of high-volatility commercial real estate, or HVCRE, loans rose in the second quarter to $41.00 billion, up 19.9% from the prior quarter but down 3.8% from the year-ago total, according to S&P Global Market Intelligence data. The analysis includes U.S. banks and thrifts that did not opt into the community bank leverage ratio framework and have at least $1 billion in total assets based on regulatory filings as of June 30.

Total HVCRE loans represented 0.28% of risk-weighted assets, up from 0.24% in the first quarter but down from 0.33% in the year-ago quarter.

Top HVCRE loan lenders

Goldman Sachs Group Inc. had the largest portfolio of HVCRE loans with $4.15 billion, up 11.1% from the last quarter's total. The firm also topped the HVCRE list at the end of 2021 and in the first quarter.

Among the banks with HVCRE loan balances over $1 billion for the quarter, only Goldman Sachs and Prosperity Bancshares Inc. grew their portfolios sequentially: Prosperity Bancshares' total of $1.54 billion was up 2.4% the prior quarter. U.S. Bancorp, which had the second-largest HVCRE balance for the quarter with $2.05 billion in loans, reported a 7.8% decline in the size of its portfolio, while PNC Financial Services Group Inc., Wells Fargo & Co. and Truist Financial Corp. each posted double-digit percent declines.

The largest percent decline belonged to fifth-place Wells Fargo, which shrank its HVCRE loan balance by 17.1% to $1.21 billion. Northern Trust Corp. posted the largest percent increase in HVCRE loans in the analysis, increasing its balance by 16.2% to $376.4 million.

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In a second-quarter earnings conference call July 27, Prosperity Bancshares Senior Chairman and CEO David Zalman said construction and home-buying activity in the bank's markets were slowing.

"I wouldn't call it a recession as much as I would call this normalization," he said. "I mean, who wants to live with 20% increases in home sales every year, who wants to live with 8% and 10% inflation, who wants to wait five months to get a washer-dryer?"

He added: "When I look at our loans, yes, I see the consumer may be pulling back a little bit in the housing market in there. But when you look at our commercial loans, they're probably stronger than ever right now."

Ratio of HVCRE loans to risk-weighted assets

Many, La.-based Sabine State Bank and Trust Co.'s $209.9 million in HVCRE loans represented 21.98% of its risk-weighted assets, the highest such percentage in the analysis.

Prosperity Bancshares, with $37.42 billion in total assets, was the largest bank in the analysis at which HVCRE loans represented more than 6% of risk-weighted assets. Its $1.54 billion in HVCRE loans totaled 7.10% of risk-weighted assets for the quarter.