Research
October 27, 2024 | By Michael Lucas
Policy Issues
Economy

Wisconsin's Biggest Bank Is Worried

The Associated Bank of Wisconsin is in a very precarious position. In the aftermath of Covid-era lockdowns, a huge portion of their Commercial Real Estate holdings may have deteriorated so much in value that they are now flirting with insolvency.

***UPDATE***

A new graph showing CRE exposure for the 25 largest banks in Wisconsin is now included at the end of the article.

Click the image to enlarge.

Wisconsin's Associated Bank

The largest Wisconsin-based bank, the Associated Bank of Green Bay, is in a very precarious position.

Like many other banks in the U.S., the Associated Bank is weathering a severe financial storm that could spell disaster for America's financial system. In the wake of five bank failures in 2023––notably Silicon Valley, Signature, and First Republic––many banks are skeptical that they'll be able to remain solvent through the year 2025. So far 2024 has taken two more banks to the grave, albeit small ones, due to worsening conditions in the financial sector. Unfortunately, the financial problems currently terrorizing U.S. banks aren't going away any time soon. The damage has been done and the cake has been baked, and it is only a matter of time before more banks fail.

The Associated Bank is one such bank worried about its financial stability––as it should be. As the 49th largest bank in the U.S.––owning more than $41.5 billion worth of assets and holding 13% of all deposits in the state of Wisconsin––the Associated Bank (AB) is a major source of financing for Wisconsin industry. Its failure could guarantee that the Wisconsin economy remain stagnant for many years to come, as businesses seeking capital suddenly lose access to a major source of financing.

The cause of all this? The federal government's unilateral decision to lockdown the economy, thereby forcing the early retirement of commercial real estate.

  

The Big Picture

  

  

The graph above from Trepp (click here if graph does not display) shows that overall delinquency rates for Commercial Mortgage-Backed Securities (CMBS) have increased from 4.4% to 5.7% over the last twelve months, with office MBSs  having faired the worst––increasing from 5.58% to a punishingly high 8.36%. The relatively high delinquency rates for these different kinds of CMBSs indicate that high-value commercial properties are experiencing huge losses. 

CMBSs tend to be composed of mid- to high-value properties; or rather, what used to be mid- to high-value properties. A decrease in their profitability and the subsequent inability of borrowers to make their mortgage payments indicate that the market value of these assets are rapidly deteriorating. If their values fall too much, banks could be underwater; i.e. insolvent.

Likewise, delinquency data for non-securitized CRE loans––typically low- to mid-level valued properties––have also entered into delinquency at higher rates (graph below).

  

  

After falling to an all-time low in the second quarter of 2022, CRE delinquencies have increased from .63% to 1.42% in Q3:2024. As an asset class, CRE loans amount to more than $3 trillion. If even 1% of these enter into default and are marked as total losses, the losses incurred by banks would amount to $30 billion––three-fourths of the asset value of Wisconsin's Associated Bank. In the next two years, research by Erica Jiang, et al. estimates that anywhere from 31-385 banks could fail from CRE distress alone (p. 16).

This is because more than $500 billion of CRE mortgages mature this year and next year (table below). And many more billions mature in the years to come.

  

  

When these mortgages reach the end of their term, the ownership of the property reverts to the bank if the borrower was delinquent. When the CRE loan was made, a property may have been assessed at a value of $1 million. The bank then gets to add a $1 million CRE loan to the asset side of its ledger. But if the borrower became delinquent and has to forfeit the property, its new assessed value might be only $.5 million. Now the bank has to get rid of that $1 million asset and replace it with a $.5 million asset. Too much of this sort of thing could cause a bank to fail.

The FDIC, for that matter––no doubt recognizing the problem with commercial real estate––recently added three more banks to its "Problem Bank List," increasing the number of problem banks from 63 in Q1:2024 to 66 in Q2 (chart 13 below).

While the list is confidential and the specific reason for banks being placed on the list is unknown, it is incredibly likely that most of these "problem banks" are significant financiers of CRE.

  

  

Both lockdowns and federal monetary policy have resulted in huge swathes of real estate plummeting in value. Banks like the Associated Bank who are heavily invested in CRE are now scrambling in a desperate attempt to find buyers for their now-defunct commercial real estate.

In the meantime, these banks are delaying marking their CRE loans as losses. So far the only banks to have reported their CRE assets as losses have been big banks. Earlier in July, The Conference Board's chief economist, Dana Peterson, wrote for the Harvard Business Review that "CRE loan losses for the largest banks spiked to 0.6% in early 2024, while other banks are reporting virtually zero losses" [emphasis added].

Peterson then explained why these other, smaller banks aren't following suit:

  

The reason for the different behaviors is that the biggest banks face greater regulatory scrutiny and are required to maintain larger capital cushions, prompting swifter realization and write-offs of souring loans. Smaller and midsize financial institutions—many of them regional and community banks—are evidently not marking down CRE loan losses but may be managing stresses differently.

These institutions are likely engaging in “extend and pretend” behaviors that lengthen loan maturities with the hope that property valuations will recover in the future.

––Dana Peterson, chief economist at The Conference Board

"CRE Lending May Expose Us To Increased Risks"

The Associated Bank is likely one of many banks "extending and pretending." On the one hand, AB hasn't reported significant losses on these assets. But on the other hand, they admit, openly, that their CRE assets are risky and experiencing "downward pressure," a euphemism for "losses."

In Associated Bank's annual 10-K report filed with the SEC in February earlier this year, they stated that as of December 2023,

  

[A]pproximately 62% of our loan portfolio consisted of commercial and industrial, real estate construction, and CRE loans (collectively, "commercial loans"). Commercial loans are generally viewed as having more inherent risk of default than residential mortgage loans or other consumer loans. Further, the commercial loan balance per borrower is typically larger than that for residential mortgage loans and other consumer loans, implying higher potential losses on an individual loan basis. 

Because our loan portfolio contains a number of commercial loans with balances over $25 million, the deterioration of one or a few of these loans could cause a significant increase in nonaccrual loans, which could have a material adverse effect on our financial condition and results of operations.

––Associated Bank, 2023 "10-K" filing

  

They continued, saying that at the end of 2023 their "CRE loans...totaled $8.5 billion, or 29%, of our total loan portfolio... [and that] CRE markets have been facing downward pressure since 2022 due in large part to increasing interest rates and declining property values" (p. 21).

This statement is corroborated by the FDIC's Quarterly Banking Profile on the Second Quarter of 2024 whereby U.S. banks have seen delinquency and nonaccrual rates for CRE loans skyrocket (chart 10 below). Again, take note that the increase in reported losses has come, overwhelmingly, from large banks. Not smaller banks like Associated Bank.

  

  

In line with what Dana Peterson has said, large banks have reported their losses on these CRE assets because the FDIC places more regulatory pressure on them to do so. But the reason they've managed to remain solvent despite the regulatory requirement to report these losses is because they don't hold CRE assets at high rates (as a % of their total assets), just high volumes (total $ value).

Small- and mid-size banks––called community and regional banks, respectively––are not beholden to the same level of reporting standards. But if community and regional banks have experienced CRE delinquencies at the same 5% rate that large banks are reporting, then dozens, if not hundreds, of banks could be insolvent right now.

The impact of this deterioration in the quality of CRE assets is made even more apparent when we look at the unrealized losses incurred by securities and which have yet to materialize on these banks' ledgers (chart 7 below).

  

  

As of Q2:2024, total unrealized losses amount to "$512.9 billion." As you can see, unrealized losses began to manifest immediately after lockdowns and stay-at-home orders were lifted. Since banks, investors and traders fully expected commercial tenants to return (office building tenants, in particular), the losses on CRE investment securities (i.e. CMBSs) did not appear until tenants made it well-known that they were going to continue working from home. This sudden drop-off of demand is the underlying reason for the plummeting value of this commercial real estate and why CRE borrowers have become delinquent on their loans––there isn't enough demand to turn a profit and make their loan payments.

This asset value deterioration, in conjunction with rising interest rates which reduced the market value of U.S. bonds held by banks (the principal reason Silicon Valley Bank went bust), explains the perpetual depth of banks' unrealized losses (read section: "How Capital Gains Work" to learn about unrealized losses).

For Associated Bank and others like them, the deterioration in the value of the CRE asset class signals to depositors with uninsured deposits (deposits > $250K) that they should withdraw their funds if they suspect their bank may become insolvent. In other words, a collapse in CRE values could spur a good-ol'-fashioned bank run on hundreds of banks.

The Risk Facing Associated Bank

The Associated Bank is contending with one ultimate risk caused by two proximate problems: the ultimate risk they face is bankruptcy due to insolvency; the proximate causes of this insolvency would be losses on their CRE assets, and losses on investment securities like government bonds.

According to AB's most recent Call Report (Q2:2024 Call Report here), AB ended the second quarter with $41.57 billion in assets (p. 15, line 12), $37.42 billion in liabilities (p. 15, line 21), and therefore $4.15 billion in Bank Equity Capital (p. 16, line 27.a). Additionally, their Tier 1 Capital was $3.26 billion (p. 51, line 26) and their adjusted Average Total Consolidated Assets were $40.1 billion (p. 52, line 30).

This means their equity to asset ratio (Shareholder Equity Ratio = Equity / Assets) was 10%, i.e. total equity was 10% of total assets; and their leverage ratio (Tier 1 Leverage Ratio = Tier 1 Capital / Consolidated Assets) was 8.13% (p. 52, line 31.a), i.e. the amount of highly liquid capital (assets which can quickly be converted into cash) at their disposal was enough to absorb an 8.13% decrease in the value of their adjusted total assets

Bank Equity Capital and Tier 1 Capital are two ways of looking at how much "cushion" or "protection" a bank has against losses they might incur. Bank Equity Capital consists of cash owned by the bank and other assets which can quickly be converted to cash. Tier 1 Capital is roughly the same thing, except the assets included in Tier 1 Capital can be converted to cash very quickly; hence why it is considered "high quality" capital. The greater either of these things are the safer and more protected a bank is from any sort of asset deterioration, and the more likely they are to be able to withstand a downturn in the market.

In short, AB was solvent through the second quarter because the value of its assets were greater than the value of its liabilities, and because they had a significant amount of high quality "Tier 1" capital to cover any potential losses.

The left and right axes are not on the same scale. The black bars, representing "Total Liabilities", are higher than the blue bars, but the values of the black bars are actually smaller.

  

Yet Associated Bank's current status as a solvent entity rests upon the value of their CRE portfolio depreciating no more than their current level of equity. As they said, a significant portion of their loan portfolio is comprised of high-risk commercial and commercial real estate loans.

The table below shows the fundamentals of the bank and their exposure to CRE; i.e. how sensitive they are to downturns in the CRE market. To do this, we follow the method described by FAU's Dr. Rebel Cole (see: here and here).

  

  

Columns "J "and "K" show that Associated Bank's CRE leverage is 263% when using a broad measure of capital, and 334% when using a high quality measure of capital––"Tier 1 Capital." Any bank which holds an asset class at rates higher than 300% of capital is considered to be at "high risk" of liquidity problems or insolvency.

To understand these percentages better, imagine that the value of a bank's CRE assets were equal to their equity/capital. Their CRE holdings, then, would be 100% of their capital. In this case, the bank's CRE would have to lose 100% of its value to wipe out all of their capital––their "cushion." Any asset losing 100% of its value isn't very likely, so banks with CRE exposures of 100% are essentially safe. 

On the other hand, if the bank's CRE was 200% of their capital, the bank's CRE would only have to lose 50% of its value to wipe out all of their capital. A 50% decline in value is still unlikely but within the realm of possibilities if the CRE market experiences serious problems. But now, imagine that a bank's CRE assets were 3 times, or 300%, of their capital. Holding this much CRE means that its value would only have to fall by 33.3% to wipe out all of the bank's capital. This is a much more likely scenario that has already materialized for the biggest banks. Following this reasoning, a bank holding CRE at higher and higher rates is even more sensitive to changes in the value of CRE and therefore more at risk of insolvency and bankruptcy.

The AB is in this high risk position, in part, because so much of its assets consist of loans and leases. Banks, of course, are in the business of making loans. But by their nature, loans are risky and sensitive to interest rates. The profitability of these loans depends on the market being healthy enough to sustain profits. The fact that these loans consist of CRE to a high degree adds another layer of risk to an already risky situation.

  

  

More than 70% of AB's assets are in the form of loans and leases to borrowers. If we look at the kind of loans Associated Bank originates, we can see their predisposition toward commercial real estate properties.

  

  

The table above shows that 57% of their loans are secured by some kind of property, and that another 23% are issued for the purpose of financing commercial and industrial activities. If we look at the details of the AB's latest Call Report (specifically page 20 and 21), we can sum the specific assets that comprise CRE. The bottom left corner of the table shows that AB has nearly $11 billion dollars worth of CRE loans, comprising 37% of their loan portfolio.

As mentioned earlier, Dana Peterson speculated that small- and mid-size banks aren't declaring the losses on defunct CRE assets. This is true for AB. On page 10 of the report, AB declares that between January and June it only incurred $47.3 million worth of charge-offs (non-payments) for all their loans. In other words, AB is claiming that in the aftermath of the lockdowns, record-high inflation and massive commercial losses that led to countless business closures, that they've only incurred losses amounting to .16% of their loan portfolio.

Considering that they have nearly $17 billion worth of loans maturing or repricing within the next three months (that is, loans which have already matured as of last month), their next call report ought to claim severe losses.

Given that office real estate nationwide is vacant at a rate of more than 40%, there is no conceivable way in which AB's real losses are less than hundreds of millions, if not billions of dollars.

  

  

At most, Associated Bank can only afford a 38% decline in the value of their CRE assets. In that case, the entirety of the bank's equity will have been wiped out and their assets will be exactly equal to their liabilities. Any decline greater than this would lead to their insolvency.

While AB is likely most concerned about their CRE assets, there is also cause for concern regarding their holdings of government securities. Their call report, in section "Schedule RC-B - Securities" declares holdings of $1.66 billion of state and municipal securities, $950 million in mortgage-backed securities issued or guaranteed by either Fannie and Ginnie Mae or Freddie Mac, $340 million of other residential mortgage-backed securities and $640 million in commercial mortgage-backed securities issued or guranteed by Fannie, Freddie or Ginnie. All told, AB's securities portfolio is $3.8 billion, roughly that of their Tier 1 capital.

  

  

Since these securities are either sensitive to interest rates (in the case of government bonds) or dependent upon the value of real estate (in the case of commercial mortgage-backed securities) these assets expose Associated Bank to additional risk––risk that is not easily dismissed by AB's particularly high level of uninsured depositors.

The table below shows that more than 43% of their deposits are uninsured, meaning that the depositors who own these funds are at risk of losing them should AB declare insolvency or go bankrupt. Typically, uninsured deposits of more than 50% are considered to be high risk, but any significant degree of asset deterioration could prompt these depositors to "flee" and withdraw their funds if they think AB could go bust.

This risk of uninsured depositors withdrawing their funds is called a "liquidity risk". If a significant portion of these depositors withdraw their funds, it would entail AB not being able to meet its cash-flow requirements; i.e. paying its short-term bills. So long as AB's assets are enough to cover their liabilities this posses no definite risk to AB other than a temporary headache while they attempt to liquidate assets and provide depositors their funds. However, if a bank run does occur, and AB is forced to sell assets at a fair market value that is less than their book value, a bank run could reveal AB's poor financials and lead to their insolvency.

For this reason, AB and others want to avoid bank runs at all costs if they believe that the current market value of the assets they would need to sell to provide these depositors with their funds are insufficient to remain solvent.

  

  

One can only hope that Associated Bank has remained vigilant and not over-extended itself into the commercial real estate market and that it continues to remain a source of capital financing for Wisconsin. But given the national trends and the current state of the national and Wisconsin economy (see: The Real Wisconsin Economy), AB's future looks rather bleak. However, it remains entirely possible that AB has managed to invest overwhelmingly in CRE properties which have remained profitable and avoided delinquency. Time will tell.

The MacIver Institute will continue to track the financials of the Associated Bank and report on any significant changes.


If you are interested in looking at the bank's financial statement yourself, you can visit (https://cdr.ffiec.gov/public/M...). Select "Call Report" from the Report drop-down menu. Then, select "6/30/2024" in the "Report Date" field. Enter "Associated Bank" in the "Institution Name" field and select "Wisconsin" from the drop-down menu of the "State or Territory" field. Finally, click "Search Banks."

Refer to the tables above, particularly the third table called "Loan Composition from Schedule RC-C Part 1." Once you open the report, scroll down to the schedule called "Schedule RC-C Part 1". It begins on page 20.

Next, add the numbers from lines 1.a.2, 1.d, 1.e.1, 1.e.2, M.3 on page 21, and 1.c.1.b from page 32. Take this number and divide it by the bank's Tier 1 Capital (page 51, line 26.) which can be found in the schedule "Schedule RC-R Part 1."

If you would like to do this for your personal bank, follow the same steps above but use the Call Report submitted by your personal bank.

Make sure the date you have selected is 6/30/24 because the 9/30/24 reports may not yet be available. Check for a 9/30/24 report just in case. The specific page numbers where the CRE values are listed may be different, so make sure you scroll to the correct Schedule. Fortunately, all the line numbers should still be the same as those listed above.

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