Regional banks' next problem — apartment building loans

• Some regional banks are now facing stress in their portfolios of apartment loans.

The big picture: Banks are the largest contingent of lenders to apartment buildings, providing nearly 40% of the financing to the sector, according to the Mortgage Bankers Association.

• The problem is higher interest rates as well as a glut of new buildings in key growth markets like Texas and Florida (many other areas of the country are short of housing, especially single-family homes).

Backstory: Following the housing bust of 2008-09, growth in loans on apartments surged, as the collapse of single-family home construction implied that more Americans would stay renters for longer, and demand for apartments and higher rents would likely follow.

• The boom in apartment lending — which grew much more quickly than the much larger market for single-family homes — continued for the better part of 15 years, crescendoing in 2021 and 2022.
• At that time, the soaring price of buying a house provided yet another reason to expect apartment demand to remain strong.

Yes, but: These bets suddenly seem much riskier.

What happened: The post-pandemic bout of inflation raised building costs.

• Simultaneously, a surge of building — particularly in Sunbelt markets — has jacked up inventories, leading to lower rents and lower occupancy.
• Other costs, such as insurance premiums, especially in flood-prone areas like coastal Florida, have risen significantly.
• And most importantly, interest rates have risen sharply — and hundreds of billions of dollars worth of mortgages need to be refinanced this year.

By the numbers: Real estate research firm Trepp estimates that more than $350 billion in apartment building bank loans will mature between 2023 and 2027, with the vast majority needing to be refinanced.

• "There are huge supplies of apartment units coming to market in the coming year, especially in markets like the Sunbelt, and the majority of these multifamily loans are made by regional banks," analysts wrote in a Trepp report late last year.

Between the lines: For building owners who received their initial loans at the rock bottom rates of 2021 — around 3% — refinancing at today's rates of around 6% drastically changes the simple math of owning of an apartment building, said Kiran Raichura, an economist following the property markets at research firm Capital Economics.

• For many of these borrowers, their income payments "aren't sufficient to pay off [the] interest each month or each quarter," Raichura said
• To refinance, some of these building owners are going to have to write big checks, effectively taking out smaller mortgages at these new higher rates, to ensure their income stays above their costs on the project.
• The risk is that some of these building owners may not have the cash, potentially setting up a wave of messy defaults.

On the other hand: Bankers have been saying that the long-term logic of the apartment business still makes sense, even if some markets might be a bit overbuilt at the moment.

• After all, the U.S. continues to suffer from a shortage of single-family homes, which means a lot of people will have to rent.
• That means the buildings that serve as the collateral for these loans still have a lot of value, which will mitigate any serious bank losses.

What they're saying

It's earnings season, so bankers and finance execs are facing questions about their exposure to souring loans on apartment buildings.

A sampling of their responses:

• In the multifamily space, "what we've seen is a surge of new supply that was put in place during the low-rate period when values had moved up a lot, and that's going to take probably 12 months, maybe a little longer to work through," Stephen Schwarzman, CEO of private equity giant Blackstone, said Thursday on its earnings call.
• "What we are seeing is the multifamily portfolio seeing some increase in 'criticized,'" Derek Steward, chief credit officer at Zions Bancorp, of Salt Lake City, told analysts. (He's referring to criticized loans, an industry term for loans that are thought to be in danger of defaulting or becoming a problem.) Construction delays, higher interest costs, and emptier-than-expected buildings are the driving dynamics, Seward said.
• Daryl N. Bible, CFO at Buffalo-based M&T Bank, told analysts that the biggest increases in the bank's criticized loans came from the multifamily segment and that rising rates are "really what's driving that."
• "We are aware of some of the pressure on multifamily," said JPMorgan CFO Jeremy Barnum, who added that the bank doesn't have big exposure to the regions that are under the most pressure.

The bottom line: It remains to be seen whether the apartment building business will suffer a small slump, or slide into a more serious bust that claims banks as collateral damage. But it's shaping up to be a focal point for financial worry warts in 2024.