Mobius Intel Brief

• Commercial foreclosures jumped 117% YoY in March, reaching their highest levels since 2015.

• Office loan delinquency rates reached 6.8% in 1Q24, nearly three times higher than in 1Q23.

• Small and regional banks hold roughly 80% of outstanding CRE debt.

• Takeaways: Last week, Republic First Bancorp (Republic Bank) became the first U.S. bank failure of 2024. Unrealized losses on CRE loans are expected to pressure regional lenders as interest rates remain higher for longer, leading to higher reserve ratios and a shrinking credit pool for borrowers. While federal officials say a regional banking crisis would have a limited effect on large lenders, this stance only acknowledges the first-order consequences of souring CRE loans. If regional banks begin to falter, large lenders will assume a higher share of risk for syndicated loans, ultimately forcing large banks to resize their debt appetite accordingly. Weakness in CRE debt could expand to affect financing opportunities and borrowing costs for energy and commodity-impacted businesses. Borrowers exposed to price volatility will carry a risk premium in a constrained lending environment.

Read Time: 3 min.

Foreclosures v. Commodities

Resilient inflation in 2024 has hardened the Fed’s outlook for higher-for-longer interest rates. While markets remain optimistic about the prospects of a soft landing, underlying weaknesses on bank balance sheets are an underappreciated risk factor for energy and commodity-impacted businesses.

Overindexed to Offices

Last week, Republic First Bancorp became the first U.S. bank to fail in 2024, a harbinger of the pressure on regional banks whose portfolios are heavily exposed to a deteriorating commercial real estate (CRE) market.

Like many regional lenders, CRE loans accounted for nearly half of Republic Bank’s loan portfolio, tying its balance sheet to a sector still reeling from the remote work trends that began during COVID.

As shown below, CRE foreclosures are mounting rapidly. Total U.S. commercial foreclosures increased 117% YoY in March, nearly 4.5 times higher than the monthly low of 141 in May 2020 and the highest figure since 2015.

Similarly, delinquency rates on commercial office mortgages grew to 6.8% in 1Q24 from approximately 2.7% a year earlier.

Approximately $940 billion (20%) of the $4.7 trillion of outstanding CRE debt will mature this year. The outsized share of CRE loans held by regional banks means unrealized losses will likely force more regional bank failures through 2024.

Risks to Energy and Commodities

Republic First’s failure is an early signal of pressure across the regional lending sector. Last week, Valley National Bancorp and Eagle Bancorp highlighted the impact of CRE loan exposure on earnings. In January, New York Community Bank posted a surprise fourth-quarter loss resulting from office and other CRE loans.

Outside of CRE, regional banks are critical financing streams for capital-intensive businesses such as energy and other commodity production, both directly and via participation in syndicated lending.

For energy and commodity-exposed businesses, several risks are of note, including:

• Reduced financing capacity: If regional banks succumb to losses from CRE debt, lead lenders (typically large banks) of syndicated loans will have fewer parties to mitigate default risk. As a result, large lenders will likely reduce their debt appetite appropriately. Similarly, regional banks with heavy exposure to souring CRE loans will have limited capacity to deploy new capital.

• Increased cost of capital: Perceived risk to commercial lending will likely result in higher interest rates for energy- and commodity-impacted businesses with cash flow volatility.

• Regulatory and policy response: Last year’s high-profile collapse of Silicon Valley Bank, Signature Bank, and First Republic Bank invited stricter regulations and capital requirements for regional lenders. The FDIC is already pressing regional lenders to adjust uninsured deposit reporting. A consecutive year of turmoil for regional banks will support more regulatory oversight, further complicating the financing market for traditional energy and commodity industry stakeholders.

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