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Bad loans are becoming a real problem for regional banks

Office buildings in southern California. A healthcare operator in the Northeast. A bankrupt oil and gas company in the Atlanta suburbs.

These were among the assets that became the source of lending problems for regional banks in the third quarter as corporate borrowers and commercial real estate began to show more signs of strain.

In recent weeks many mid-sized financial institutions across the country reported that nonperforming loans, a measure that tracks borrowers that are behind on their payments, rose during the third quarter. They also disclosed mounting costs from unpaid debts written off as losses.

Of 18 regional banks analyzed by Yahoo Finance with assets ranging from $50 billion to $250 billion, 15 reported jumps in nonperforming loans when compared to the same year-ago period. The average rise was 80% more than the third quarter of 2022, and up 8% when compared to the second quarter of this year.

Charge-offs — a measure of unpaid debts written off as losses — also rose at 15 of the 18 banks compared with the same year-ago period.

"Investors have been bracing for credit trends to weaken, but it was always theoretical, whereas now, we’re actually seeing it," David Chiaverini, a regional and mid-sized bank analyst for Wedbush, told Yahoo Finance.

"We could very well be at the beginning stage of a credit cycle," he added.

CHICAGO, ILLINOIS - APRIL 20: A sign advertises vacant retail space for lease in the Loop on April 20, 2023 in Chicago, Illinois. Chicago's downtown is littered with vacant retail space as it continues to struggle after office workers who fled downtown during the pandemic have been slow to return. The city has also struggled to deal with a spate of mob violence that has plagued the business district for the past couple of years, which last weekend resulted in two people shot, a young couple visiting the city badly beaten and robbed, and several vehicles damaged.  (Photo by Scott Olson/Getty Images)
A 'for lease' sign in downtown Chicago, one of many cities with lots of vacant space. (Photo by Scott Olson/Getty Images) (Scott Olson via Getty Images)

The KBW Nasdaq Bank Index (BKX) fell Friday by 2.3%, hitting a level last seen in September 2020, as worries mount about the future profitability of the industry if interest rates remain elevated for some time. Stocks of mid-sized regional banks have fallen more than giant institutions like JPMorgan Chase.

But Scott Siefers, an analyst with Piper Sandler, said many of the loan problems that popped up at regional banks during the third quarter were "idiosyncratic" issues that some are referring to as "one-offs" or "two-offs" that can be chalked up to "a particular circumstance."

"Having said that, it feels like the further along we go, the more of these could go from one-off issues to just broader deterioration in credit," said Siefers, adding that "we aren't quite there yet."

'There will be losses for sure'

Regional banks are particularly vulnerable to commercial real estate weaknesses because they hold a lot more exposure to those properties than their larger rivals.

Many began ramping up their bets on commercial real estate in the aftermath of the 2008 financial crisis, which was triggered by a housing bust, and stuck with it even after the pandemic emptied out many city-center properties.

Now a steep decline in property values and rising interest rates are making things even more challenging for borrowers as lots of debt comes due for repayment. There is a total of $331 billion in US commercial and multifamily mortgage debt set to mature in 2023, according to a second quarter report from the Mortgage Bankers Association.

The issue is under scrutiny by regulators. "All of the bank regulators are working with banks that have, you know, concentrations of troubled real estate to work it out," Federal Reserve Chairman Jerome Powell said earlier this month at the New York Economics Club.

Federal Reserve Chairman Jerome Powell speaks at a meeting of the Economic Club of New York in New York, Thursday, Oct. 19, 2023. (AP Photo/Seth Wenig)
Federal Reserve Chairman Jerome Powell speaks at a meeting of the Economic Club of New York in New York. (AP Photo/Seth Wenig) (ASSOCIATED PRESS)

"Smaller banks have proportionately much larger exposure to real estate," he added, and "there will be losses for sure."

Souring loans

One regional bank that highlighted some of its commercial real estate challenges in the third quarter was New York Community Bank (NYCB), which said its heap of souring loans grew to $642 million. That was up 64% from last quarter and eight times as large compared to the year-ago quarter.

That surge, it said, came largely from two office-related loans, one in Syracuse, New York, and another in Manhattan.

In Utah, Salt Lake City-based Zions (ZION) moved $64 million in loans this quarter to nonperforming status, the bulk of which came from two suburban office properties in southern California and a business loan the bank plans to sell in the fourth quarter.

"Those were loans where the properties were being improved and then when the project got completed, they had problems leasing it," Tim Coffey, a bank analyst with Janney, told Yahoo Finance. "That totally makes sense in this environment, but it is kind of unusual."

At M&T Bank (MTB), which is based in Buffalo, New York, it wrote off $96 million in bad loans tied largely to office buildings in Washington D.C., Boston, and Connecticut, as well as a large healthcare company operating in New York and Pennsylvania.

Nonperforming loans tied to real estate can go into default or they can be resolved, said Stijn Van Nieuwerburgh, a real estate professor at Columbia Business School. But it can take "years before getting resolved," he added.

When real estate loans go bad, banks can sell a borrower's property to get cash. Recovery can be more challenging with business loans since collateral can include intellectual property or cash flow in addition to real estate and equipment.


One $219 million business loan shared by several regional banks turned into a problem in August when Alpharetta, Ga.-based Mountain Express Oil filed to liquidate its holdings in Chapter 7 bankruptcy court.

The company supplies fuel to convenience stores and travel centers and leases real estate at many of those locations. Its lawyer said Mountain Express filed for bankruptcy because it was not able to work out new agreements with its major landlord after the company ran into liquidity problems.

The bankruptcy of this oil and gas distributor rippled through a number of Southeastern banks — including First Horizon (FHN), Pinnacle (PNFP), Synovus (SNV), and Cadence Bank (CADE) — as well as Los Angeles-based Hope Bank.

UKRAINE - 2021/06/26: In this photo illustration a Synovus Financial Corporation logo is seen on a smartphone and a pc screen. (Photo Illustration by Pavlo Gonchar/SOPA Images/LightRocket via Getty Images)
Synovus was among the banks that disclosed charge offs from a loan tied to an oil-and-gas distributor. (Photo Illustration by Pavlo Gonchar/SOPA Images/LightRocket via Getty Images) (SOPA Images via Getty Images)

Pinnacle Bank took a $9.5 million charge-off on the loan, with CEO Harold Carpenter calling it as "a little bit of an anomaly."

Executives for both First Horizon and Hope Bank described their $72 million and $23 million charge-offs from the loss as "idiosyncratic."

"Along with other banks in the syndicate, we are in the process of evaluating and assessing all avenues of recovery," Kevin Blair, CEO of Columbus, Ga.-based Synovus told analysts after disclosing a $23 million charge-off related to the loan.

David Hollerith is a senior reporter for Yahoo Finance covering banking and crypto.

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