Commercial real estate exposure: How investor should assess risk

New York Community Bancorp (NYCB) will receive a $1 billion rescue from a group of investors led by former US Treasury Secretary Steven Mnuchin. The bank absorbed some of the assets of the failed Signature Bank, taking on billions in loans that subjected them to tighter regulatory standards. NYCB is also threatened by its high exposure to commercial real estate, which has fallen significantly in value since the rise of remote work.

WaFd Bank CEO Brent Beardall (WaFd) joins Yahoo Finance to discuss the $1 billion rescue plan for NYCB and what investors need to keep in mind regarding regional banks and commercial real estate.

Beardall explains that commercial real estate is too broad a sector to be categorized as a risk across the board. To understand the nature of investors' exposure to commercial real estate, Beardall highlights three key takeaways: "Number one is location: it's not secret, everyone knows that with real estate it's all about location, location, location...Number two is to understand how much equity these borrowers put into the deals. Because it tells you how long are they going to go along trying to solve the problem. If they have a lot of equity in the deals, they're going to be with you, they're going to work with you really hard with you to get it right. And then lastly is the sponsor. You need to understand how is the sponsor going to behave. Are they going to be quick to cut ties and say it's your problem or are they going to work with you through the problems?"

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video transcript

SEANA SMITH: The collapse of Silicon Valley Bank Signature and First Republic represent three of the biggest bank failures in US history. New York Community Bancorp took on some of the assets of the failed Signature Bank, absorbing billions in loans, pushing the lender above the $100 billion threshold that subjects banks to higher regulatory standards, including needing to hold more capital against future losses.

BRAD SMITH: That's right. And so NYCB now saying that it's the reason that it slashed its dividend and set aside more money. But loan loss money aside. The bank is under pressure because of its high exposure to commercial real estate, which has fallen significantly in value since the pandemic and the rise of remote work.

So what does the road ahead look like for regionals? We're joined by Brent Beardall, who is the CEO of WaFd Bank. Thanks so much for taking the time. What does that road ahead look like from your purview?

BRENT BEARDALL: You know, put it this way. The road ahead looks a lot better than it did a year ago. Regional banks are actually very strong. And I was so glad to see the infusion of capital into New York Community Bank. It had some problems. And I think that capital will help address those problems.

SEANA SMITH: Brent, when we talk about the need for regionals here to reassure investors, skeptical investors who maybe aren't sure just about the risk that some of these regional banks who have a high exposure to CRE, what the road ahead could look like, what would your message to those skeptical investors be?

BRENT BEARDALL: Thank you for asking the question. One of my favorite things to do is to try to educate people about commercial real estate. Commercial real estate is such a broad category. Literally, it means 1,000 different things.

What's in commercial real estate? You have office buildings, which, of course, is the highest risk right now. You also have hospitality. You have hotels. You have apartments. You have warehouses. You have self-storage facilities. You have car wash. It means so many different things.

So to me, it's too broad of a category to say, hey, look how much exposure you have to commercial real estate. The question is, what kind of commercial real estate? And then once you understand what kind of commercial real estate, an investor really needs to know three things from my perspective.

Number one, location. It's no secret. Everyone knows that with real estate, it's all about location, location, location. If you are downtown San Francisco, right now you probably have a problem. if you're in Bellevue, Washington, you're probably doing pretty well, or Salt Lake City, most of the markets that we operate in.

We all see the headlines of what's happening in these major cities. And they have real problems. But you can't extrapolate that to the overall market. So number one is location. Number two is to understand how much equity these borrowers put into the deals because it tells you how long are they gonna go along trying to solve the problem. If they have a lot of equity in the deals, they're gonna be with you. They're gonna work with you. Really hard to get it right.

And then lastly is the sponsor. You need to understand, how is the sponsor going to behave? Are they gonna be quick to cut ties with you and say it's your problem? Or are they gonna work with you through the problems?

BRAD SMITH: And so how does this materially change the propensity of regional banks to have the same type of commercial real estate exposure that they've had in the past versus passing that off to some of the larger banks?

BRENT BEARDALL: Yeah, well, I think the real question is, do we need to pass it off to the larger banks? Is it a problem? For us at WaFd, we've now been on-- in the last 10 years, 9 of those years, we've had net recoveries. We've only had one year of net losses. Think about that.

On our commercial real estate book, we've almost had no losses in the last 10 years. So literally, if we decided strategically we wanted to change our focus from commercial real estate into another asset category, we're literally taking more risk. Is that what we want?

So I would say, don't just jump based on the headlines. But understand what kind of risk there is in the portfolios, and where do you wanna be? Commercial real estate has served us very, very well as regional banks and I think will continue to do so.

And one of the other things, if I could point out too, because one of the headlines about New York Community is, you know, they got in trouble with commercial real estate. And they did. But their issue is focused on apartments in New York City that have rent control.

And when you have rates go up 500 basis points and then all of a sudden the debt service rises, if the landlords can't increase their rents to pay for that, that's where they get squeezed. And so we have just a handful of loans in our entire portfolio that have rent control, so it's not an issue for us or the majority of banks out there.

SEANA SMITH: Brent, what is an issue for everyone on the street but particularly regional banks is where rates currently are and the pressure here for the Fed to potentially cut rates. If the Fed doesn't cut rates or if it does in fact delay rate cuts, what does that mean for your business and the consolidation narrative?

BRENT BEARDALL: You know, I think the most important thing is not necessarily what happens with rates in the short term, it's the shape of the yield curve, right? And we are now on, I think, 19 consecutive months. If you look at the inversion of the yield curve between the twos and the tens, we need to see a steepening of the yield curve.

It's not necessarily how many cuts or when those cuts happen but what happens in the yield curve. A positively sloping yield curve is good for all banks, so that's what we look forward to getting back to. And in terms of what the market thinks that's going to happen with rates, I think the market's getting ahead of the Fed.

And we've heard that with the latest Fed speak. I think this year if we get a couple of cuts, I think that will be a good thing. I don't think we're gonna see the five or six cuts the market was thinking of a month or so ago.

BRAD SMITH: For construction projects that are waiting for that pathway of cuts to really emerge, how does that pass through to some of the banks that then would be the loaners of those-- or on those projects and trying to figure out where they play a role in financing some of those projects as well?

BRENT BEARDALL: The bottom line is it makes it tougher, right? Because higher rates means it's a higher debt service. So the sponsor is going to have to come up with more cash. The lower the rate, the more proceeds the sponsor can get and the lower the debt service.

So you have a lot of sponsors waiting on the side, waiting for the Fed to act so that they can put more of the money into the actual project itself and less into the financing costs.

BRAD SMITH: Brent Beardall, thanks so much for taking the time here today. We certainly do appreciate it.

BRENT BEARDALL: Appreciate it, Brad and Seana. Thank you.

BRAD SMITH: Thanks.