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Loans backing office and multifamily properties have caused angst among bank shareholders. For example, in January, New York Community Bancorp (New York Stock Exchange: NYCB) shares fell after it increased its loan loss reserves to address weakness in the office sector and for a possible price readjustment in its multi-family portfolio, among a series of other charges it assumed.
But the largest U.S. banks are well positioned to withstand the decline in loan performance for offices and multifamily properties (i.e., apartments), Fitch Ratings said in a recent report.
Despite holding the majority of commercial loan balances, larger banks are more diversified and better positioned to withstand expected credit deterioration, particularly in office loans, Fitch's Julie Solar and Brian Thies said in the report.
“Starting in 2023 and continuing into this year, the migration of non-owner-occupied (nonOO) commercial property into non-performing loans (NPL) has accelerated and has since approached levels last seen at the peak of the global financial crisis,” they say. wrote.
And the industry is unlikely to have reached peak levels of problem loans. During the global financial crisis, peak losses on non-credit-related commercial loans did not occur until migration into non-performing status had slowed and reached a plateau.
Nonresidential real estate loan losses totaled nearly $20 billion in cumulative net charge-offs from 2009 to 2011, or 3.5 percent of average loans. Bank losses during that period included $60.8 billion in construction, $10.1 billion in owner-occupied residential real estate, and $6.8 billion in multifamily, for a total of $97 billion in residential real estate losses.
Fitch said that, to date, non-CRE loan losses of $5.8 billion have been recorded over the past three years. If performance deteriorates as seen during the global financial crisis, the industry could face an additional $33 billion in non-CRE loan losses.
However, the multifamily and office sectors are following two very different paths. As a sector that is traditionally stable over time, the multifamily sector is expected to suffer losses that are more geographically concentrated than the non-housing commercial real estate sector overall. And, over time, the multifamily sector is expected to absorb excess supply in those areas as favorable demographic trends support demand for additional housing.
The dynamics are not as favourable in the office sector, as a structural shift towards hybrid working models weakens demand. “Fitch expects recoveries on office loans to be lower than during the global financial crisis, given the structural changes in this sector,” Solar and Thies said.
According to Federal Reserve estimates, the probability of default on loans is 23%, which is higher for large offices in high-work-from-home markets. In comparison, the probability of default is 8.4% for loans to large offices in low-work-from-home markets, 1.4% for loans to small offices, and 0.5% for loans to non-small offices.
“Given the continuing trend toward hybrid work and the resulting decline in demand for office space, it is uncertain whether vacancies will recover in the short to medium term,” the report said.
Fitch said larger banks account for more than half of nonperforming commercial real estate loans as of June 30, 2024, but banks with assets between $100 billion and $250 billion have a higher percentage of problem loans. Fitch attributes the weaker credit performance of larger banks to their exposure to central business district investor-owned and official-owned properties. Meanwhile, smaller banks are likely to have office loans associated with suburban markets, which are not as affected by the shift to remote work, according to the Fed.
Of the 10 largest non-OO CRE lenders, they represent 22% of total loan balances as of June 30, 2024, while the 10 largest multifamily lenders represent 38% of loan balances, Fitch said. Wells Fargo (New York Stock Exchange: WFC) is the largest non-OO CRE lender to all U.S. banks, accounting for 42% of equity, while JPMorgan Chase (New York Stock Exchange: JPM) is the largest multifamily lender with loans representing 33% of equity as of the end of the second quarter of 2024.
Other relevant tickers: Vaneck Office and Commercial REIT ETF (DESK), Bank of America (BAC), US Bancorp (USB), Truist Bank (TFC), PNC Financial (PNC), Citigroup (C), Capital One (COF), TD Bank (TD), Santander Bank (SAN), Valley National Bank (VLY), Webster Financial (WBS), Synovus Bank (SNV).
