Rising vacancy rates, the short maturity of loans, and the loans made during low-interest periods have all contributed to escalating the current predicament. We have written about this several times, and now we aim to explore the problem through the lens of bank balance sheets to determine which ones really suffer under this issue.

To begin with, CRE loans are occupying a large portion of the U.S. banking sector's entire portfolio (Total Assets), standing at a significant 10%. CRE loans are also regarded as the most widely held loan type among banks, which is confirmed by the fact that the majority of banks (99%) have positive CRE loans. Basically, almost every bank in the U.S. is holding some type of CRE loan on their balance sheets. Therefore, it is no surprise that this is an area warranting close observation, especially because the risks posed by CRE exposure spread quite unevenly between large and small banks.

Figure 1 illustrates the average CRE concentration for banks based on their size, as a share of loans.

Community banks, which refer to small and medium sized banks, emerge as a primary source of concern due to their substantially higher exposure compared to their larger competitors. This is clearly visible in the figure, where, on average, these banks allocate 45% of their loans to CRE, while the largest banks maintain a more cautious concentration of around 12%. This difference is not unexpected, as community banks are inclined to take on more risks due to their lower capital requirements. This seemingly underscores the growing concerns surrounding community banks and their CRE portfolios, and this narrative is also heavily pushed by the media.

However, high CRE concentration alone do not inherently imply problems. The real issue arises from the combination of high concentrations, insufficient reserves, and delinquency issues. Therefore, it is essential to analyze the Coverage Ratio, which compares CRE to reserves for losses (Allowance for Loan Losses) plus Equity Capital.1 This ratio effectively measures the 'leverage' in the CRE portfolio. The higher the number, the higher the possible future risk.