Kevin O'Leary's nickname is Mr. Wonderful. But he definitely doesn't have a wonderful outlook on every potential investment.
O'Leary spoke recently on Fox Business about one particular area in which he is decidedly bearish. The Shark Tank star thinks stocks like these could be in dire trouble.
Poised to fail
It's no secret that the commercial real estate market is hurting. The COVID-19 pandemic caused a paradigm shift, with millions of Americans working from home. Some companies are insisting that their staff return to the office. However, many now have permanent work-from-home policies, or hybrid approaches where employees can work from home part of the time.
Image source: Getty Images.
Earlier this year, O'Leary's co-star on Shark Tank, Barbara Corcoran, stated in an interview with Fox Business that office vacancy rates continue to be very high in most major cities, as well as in many secondary markets. She said, "I think it's going to be a bit of a bloodbath before it gets better."
O'Leary is on the same page as Corcoran. He said in his recent Fox Business interview, "Many of these are office spaces that are in subgrade markets. But even in cities like Boston, you find lots of vacancies, you know, up to 40% of buildings."
He also believes the problems will spread beyond the commercial real estate market. O'Leary noted that many office buildings would need to refinance their bank loans but have no remaining equity. He added, "So these banks are going to fail because up to 40% of their portfolio -- I'm talking regional banks here -- are in commercial real estate."
Bank stocks with high exposure to commercial real estate
O'Leary didn't single out any bank stocks that could be in jeopardy. However, there are quite a few that do have high exposure to commercial real estate.
In May, real estate data provider Trepp conducted an analysis of 4,760 banks' publicly available regulatory data. It found that 763 of them had either commercial real estate or construction loan concentration ratios that were above the thresholds established by 2006 guidance from the Federal Deposit Insurance Corp. (FDIC).
PacWest Bancorp (PACW) ranked among the regional banks that exceeded the recommended thresholds. In July, though, PacWest announced that it was being acquired by Banc of California (BANC) in a transaction expected to close in late 2023 or early 2024.
New York Community Bancorp (NYCB -3.26%) also made the list. In its second-quarter update, the bank revealed that commercial loans made up 44% of its total loan portfolio. However, Eric Howell, New York Community Bancorp's president of commercial and private banking, said in the company's quarterly conference call that its "commercial real estate portfolio is doing extremely well."
Valley National Bancorp (VLY -5.79%) stood out as another regional bank with high exposure to commercial real estate. The company even reported significant growth in commercial real estate loans in the second quarter of 2023. However, when asked about the bank's exposure to commercial real estate and the potential for loan sales in the Q2 conference call, Valley president Thomas Iadanza replied, "We're comfortable with our return and risk requirements within our portfolio."
Is Mr. Wonderful right or wrong?
There appears to be a stark difference in opinions. Banks such as New York Community Bancorp and Valley National Bancorp express optimism despite their heavy exposure to commercial real estate. O'Leary thinks banks with such high exposure to commercial real estate could be skating on thin ice. Is Mr. Wonderful right or wrong?
O'Leary is likely on target about the overall problem. And he's not alone in his thinking. Moody's Analytics chief economist Mark Zandi tweeted a few months ago:
CRE loan delinquencies and defaults are sure to increase, causing agita for the banking system. But it shouldn't be the catalyst for a revival of the banking crisis. Limiting losses is the ample equity built up in most properties due to the big price gains during the pandemic.
-- Mark Zandi (@Markzandi) May 16, 2023
That doesn't mean that every regional bank with significant exposure to commercial real estate will fail, though. Zandi noted that consumer real estate loan defaults "shouldn't be the catalyst for a revival of the banking crisis." Also, some commercial real estate markets are stronger than others.
Investors seeking to buy regional bank stocks on the cheap should pay attention to O'Leary's warning. However, they should also recognize that different regional bank stocks don't face the same level of risk.
