Commercial real estate is a concern for U.S. regional banks - Thomson Reuters

Regional banks, already under financial stress and on the radar of regulators, now face another potential crisis in the volatile commercial real estate sector. The recent collapse of several regional banks, including Silicon Valley Bank (SVB) and Signature Bank, as well as troubled deals by Credit Suisse and First Republic Bank, have many financial industry observers worried about the banking sector and the state of the economy as a whole.

One of the major concerns is the possibility of the United States falling into a recession. Analysts and bankers say stress in the commercial real estate sector could be the next big trouble spot for regional banks and regulators as losses,''related to rising interest rates will manifest themselves in the coming months. Part of this fear stems from the possibility that every regional bank could be the next to suffer major losses. As banks report their first-quarter earnings, investors are scrutinizing the results for signs of stress or vulnerability, following the collapse of SVB last month. So far, the financial picture has not revealed any hidden bombshells, but experts say the pressure on banks' financial health is likely to become more palpable in the coming months.

The biggest worry is the impact of the banking sector on commercial real estate (CR), especially the office sector. "Compared to large''banks, small banks have 4.4 times greater exposure to QN loans in the U.S. than their larger counterparts," according to a new analysis report from JPMorgan Private Bank. "Within this group of small banks, QN loans account for 28.7% of assets, while large banks have only 6.5%," the report continues. "More worrisome is the fact that a significant percentage of these loans will require refinancing in the coming years, which will only add to the hardship for borrowers in an environment of rising interest rates. "

A separate analysis by Citigroup found that banks represent 54% of the total $5.7 trillion commercial real estate market, with small lenders holding 70% of QN loans. According to real estate data provider Trepp, by 2027, the U.S. will have to''be repaid over $1.4 trillion in QN loans, with about $270 billion having to be repaid this year.

The office sector faces significant challenges following the COVID-19 pandemic, which forced millions of employees to switch to working from home on a regular basis.

What's more, executives in some''s biggest banks point to risks in the commercial real estate sector. "Weakness continues to develop in the commercial real estate office sector," Wells Fargo CEO Charlie Scharf said on a recent earnings call with analysts. The bank set aside another $643 million in the first quarter to account for credit losses, largely due to expectations of increased defaults on QN loans.

Focus on the California market Considering that technology and venture capital were the main victims of the SVB collapse, recent data shows that California's commercial real estate market is one of the hardest hit in the country. According to commercial real estate firm Cushman & Wakefield, the average office vacancy rate in San Francisco and''Los Angeles was 21.6% in the first quarter. In addition, loan default risks for San Francisco offices are now the highest compared to all other U.S. cities. "Problems arise by geography," the JPMorgan report notes, adding that "Chicago and San Francisco are in a more challenging situation than Miami, Raleigh and Columbus, for example. "

The weakness of the BOE is likely to affect banks of all sizes, but small and regional banks have, as a percentage, the greatest exposure. "While overall exposure to weak commercial real estate subsectors differs from bank to bank, those with more than 100% of their capital invested in these segments are likely to be smaller regional institutions," JPMorgan said in the report, noting,''that Webster Financial Corporation, Valley National Bancorp and Zions Bancorporation are a few of the banks with above 100% exposure relative to their capital. "The bank's base case scenario assumes that commercial real estate prices will fall by about 10-15% in the current cycle," although for the office sector, the report shows that price declines of 30-40% in the most stressed markets would be unsurprising.