Smaller bank stocks have dropped by 8.2%

As US Treasury yields continue to climb, regional banks are facing mounting pressure from the distressed commercial real estate sector.
According to a Bloomberg report, the increase in borrowing costs has raised concerns over the stability of smaller lenders, whose balance sheets are vulnerable to a growing risk of loan defaults tied to falling property values.
Since November, smaller bank stocks have dropped by 8.2%, reflecting the impact of higher borrowing rates as the 10-year Treasury yield surged.
The rising cost of credit is intensifying the challenges for borrowers who acquired office buildings prior to the pandemic, as their properties lose value and refinancing becomes more difficult.
Steven Kelly, associate director of research at the Yale Program on Financial Stability, explained that while rising long-term yields add fragility to the banking system in the short term, they may lead to more profitability in a stable economic scenario.
A sharp rise in 10-year Treasury yields last year has likely reversed much of the progress made in reducing unrealized losses on banks’ securities, as noted by Federal Deposit Insurance Corp. chairman Martin Gruenberg in a speech on December 12.
Despite a recent rally in Treasury yields following better-than-expected inflation data, the yield has risen by about 0.3 percentage points to 4.58%, continuing to weigh on lenders.
Columbia Business School finance and real estate professor Tomasz Piskorski warned that regional banks could face greater losses on commercial real estate loans if borrowers struggle to refinance, as borrowing costs continue to rise.
Piskorski and his colleagues estimate that 14% of the $3 trillion in US commercial real estate loans are underwater, with the percentage increasing to 44% for office properties.
Bloomberg further reported that smaller lenders, which had previously offered lower down payments to borrowers before the 2022 rate hikes, are especially vulnerable. The decline in office and multifamily property values has left them with less cushion to absorb potential losses.
PNC Financial Services Group CEO Bill Demchak said that the office market remains unstable, prompting the bank to increase its reserves for sour office loans to 13.3% from 8.7% at the end of 2023, though the increase represents a small portion of the bank’s total loan portfolio.
Despite the challenges, the lower cost of deposits, aided by reduced Federal Funds rates, has contributed to maintaining stability. Steady deposit flows in the fourth quarter reduce the risk of rapid withdrawals that could force banks to sell underwater bonds. As securities near maturity, duration risk is also decreasing.
“Investors are a little less concerned about the unrealized losses, because it doesn’t look like there’s going to be forced sales like there was with Silicon Valley Bank,” said Scott Hildenbrand of Piper Sandler.
Meanwhile, bank analyst Terry McEvoy of Stephens Inc. added that discussions around unrealized losses were not a major concern during recent investor meetings.
With borrowing costs rising even as the Federal Reserve cuts rates, Piskorski cautioned that regional banks may be heading into a period of heightened fragility.
Can the banking sector withstand these pressures, or is it heading toward further instability? Share your thoughts in the comment section.