A number of US banks continued to experience delinquent commercial real estate (CRE) loans in their portfolios in the third quarter as stress in the sector continues.
Building owners who have borrowed money to finance their properties are being squeezed by high interest rates and vacant offices as employees choose to work from home. Weak demand for offices could trigger a wave of loan defaults and put pressure on banks and other lenders hoping to avoid having to sell loans at deep discounts.
As a result, banks again recorded provisions for credit losses and increases in charges compared to the previous quarter, driven by their non-performing (NPL), or delinquent, CRE loans.
“This will continue for at least a year, with NPLs continuing to rise, followed by write-downs – it’s getting really ugly,” said Rebel Cole, a professor of finance at Florida Atlantic University.
I’m sure banks try to avoid selling their worst properties because they are then forced to take a larger depreciation, and because every property sold becomes a comparable sale to the appraisers who value the properties. “
In its third-quarter earnings call, Morgan Stanley noted that it had set aside $134 million for credit losses. As with the $161 million set aside in the second quarter, the bank noted this was due to “deteriorating conditions in the commercial real estate sector.”
Other banks’ earnings results last week showed similar challenges for CRE holdings. On Tuesday, Goldman Sachs announced it had reduced its exposure to office-related CRE holdings by about 50% this year.
Bank of America reported Tuesday that its non-performing loans, or loans on which payments are at least 90 days past due, rose to nearly $5 billion in the third quarter, up from $4.27 billion in the second quarter, largely due to its CRE portfolio.
Borrowers are struggling to refinance their CRE loans as property values have fallen and interest costs have risen. About $20 billion in mortgage-backed office bonds, which bundle individual loans, mature in 2023, according to real estate data provider Trepp.
Regulators have been keeping a close eye on banks’ CRE risk. While larger banks such as JPMorgan and Goldman Sachs have relatively less exposure to CRE, smaller regional banks have greater exposure that has created challenges, according to research from JPMorgan and Citigroup.
Small banks have 4.4 times more exposure to CRE loans than their larger peers, JPMorgan found earlier this year. Citigroup found that regional or smaller lenders control 70% of CRE loans.
“A lot of these big banks are benefiting from all these different lines of business,” said Mayra Rodriguez Valladares, a risk consultant for banks and capital markets. “But once you become a regional bank or a community bank, you don’t have all that business diversity.”
Wells Fargo saw an increase in net charge-offs on its CRE portfolio compared to previous quarters. On Oct. 13, the bank reported $93 million in charge-offs on net CRE loans, compared to $79 million in the second quarter and $17 million in the first quarter.
In addition, the bank’s provision for credit losses increased by $333 million in the third quarter, primarily due to CRE. There was a $1.3 billion increase in nonaccrual CRE lending in offices.
On Oct. 13, PNC reported that the balance of unperforming CRE loans more than doubled to $723 million in the third quarter, up from $350 million in the second quarter.
“While overall credit quality remains strong across our portfolio, the pressures we expected within the commercial real estate office sector have begun to materialize,” PNC Chief Financial Officer Robert Reilly told analysts. (Reporting by Matt Tracy; Editing by Lananh Nguyen and Jonathan Oatis)