Standard & Poor’s (S&P) has recently downgraded five additional regional banks as the sector continues to face difficulties. In its latest report, S&P announced downgrades for First Commonwealth Financial Corp., M&T Bank Corp., Synovus Financial Corp., Trustmark Corp., and Valley National Bancorp. All five banks have been downgraded from a “stable” rating to a “negative” rating.

S&P has attributed the downgrades to the banks’ exposure to the troubled commercial real estate (CRE) market, which is seen as a potential indicator of future weakness. The stress in the CRE market, including reduced property prices and higher vacancies in investor-owned office properties, poses a growing challenge for banks with significant loan exposures to CRE.

While most rated banks have not reported a significant increase in delinquent and nonaccrual CRE loans, S&P believes that the rise in criticized and modified loans, as well as increasing loan maturities, could potentially lead to a significant deterioration in asset quality and performance.

Among the downgraded banks, M&T Bank Corp. stands out as having one of the highest exposures to CRE. S&P warns that further deterioration is possible for the bank, which is struggling to service over $33 billion in loans to the sector. M&T’s loan portfolio is particularly vulnerable due to its significant exposure to office loans, which have been negatively impacted by the shift to remote work caused by the Covid-19 pandemic. S&P notes that these loans are susceptible to unfavorable long-term trends.

M&T Bank Corp.’s CRE loans are higher compared to most rated U.S. banks and significantly higher compared to similarly rated regional bank peers. As of December 31, 2023, CRE loans accounted for 25% of total loans and approximately 174% of Tier 1 capital, including construction loan exposures equivalent to about 6% of total loans. Office loans, which make up nearly 4% of total loans and about 25% of Tier 1 capital, are at risk of further deterioration. However, potential losses from CRE loans, including office loans, may be partially offset by conservative loan-to-value ratios at origination.

Last month, Desmond Lachman, an insider at the International Monetary Fund (IMF), issued a warning that CRE is a significant vulnerability for the industry and could result in the failure of approximately 385 small and medium-sized banks. Lachman highlighted that over $900 billion in commercial property loans are due this year, and it will be challenging to refinance those loans given the current higher interest rates compared to when the loans were initially contracted. The defaulting of property loans could be particularly problematic for regional banks, which are a major source of financing for small and medium-sized companies. Commercial property loans constitute around 18% of these banks’ overall loan portfolios.

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