US Regional Banks Face Growing Pressure From Declining Office Loan Portfolios

Regional US banks still struggle with pressures in the office segment due to high adoption of remote work, however, reductions in interest rates could allow to mitigate the pressure for other CREs, according to the analysts.

Some ten mid-western and regional banks in the United States revealed increased non-performing loans (NPLs), or debt to commercial real estate that borrowers failed to pay on time, in the third quarter compared to the same period a year ago, according to a Reuters computation of reports.

Another problem could be the existence of a so called “maturity wall”. The deadline of loan term requires borrowers either to roll over the loans or payoff the remaining amount in full. If that is not done, it will result in defaults and distortion of balance sheets among the banks.

About $950 billion of CRE mortgages are projected to mature next year, out of which 10% are associated with offices as per S&P Global Market Intelligence.

Given the increased focus on hybrid working, it means that office loans can pose certain risks because low interest rates may not necessarily be available as a reward.

The problem is that rate cuts “may not remove office pressures in the short term” since remote and hybrid work have become the new norm, and businesses are increasingly using AI to reduce dependency on call centers, amongst other services, according to Michael Ashley Schulman, the chief investment officer at Running Point Capital.

While banks may use ‘extend and pretend’ to delay the impairment recognition, it takes its toll on the stability of financial system for which evidence was provided by the Federal Reserve Bank of New York in their paper last week.

Flagstar Financial (FLG.N), opens new tab, formerly known as New York Community Bancorp, said it wrote off $388m of its $2.6bn office portfolio.

Losing the ability of a troubled regional lender to separate CRE exposure in-part, partly caused a sector-wide crisis early this year.

KeyCorp said NPLs in its small office portfolio were 5.1% compared to 2.3 percent a year ago.
Fifth Third’s office NPLs were at 0.18% of its portfolio, an increase from 0.16% from the same period a year ago. The bank has no activity in new office CRE loan originations.

RELIEF ON THE HORIZON

Other non-office portfolios could also experience some relief if a long-awaited cycle of rate cuts commences, according to ratings agency Fitch, citing upside in multifamily loan opportunities.

“The decision by the Federal Reserve to begin interest-rate cuts last month and the subsequent ultimate cessation of quantitative tightening … should set up a better environment,” said Jason Benowitz, a senior portfolio manager at investment firm Segall Bryant & Hamill.

However, it may take banks years of effort to bury the CRE issues, whether they are still lingering.

I foresee that more difficulties will be encountered in CRE in the future years. Remote work has cut down on the demand of more office space.
Another threat similar to e-commerce adoption is also experienced in the retail space. ‘There has been a high absorption of warehouses in the pandemic period and it is now a period of the normalization,’ said Benowitz.

In the case of weaknesses, Schulman of Running Point said that lenders should be prepared enough with additional capital beyond 2025 level.

M&T Bank (MTB.N), Farmland opens new tab had total criticized office loans, or those it deemed potentially at risk of repayment, of about $1.31 billion compared with $1.22 billion in the second quarter.

U.S. Bancorp (USB.N), opens new tab said office portfolio remains under pressure despite the macro level having normalized.

Like its peers, its CRE charge-offs and NPLs rose in the quarter, with the lender blaming the deterioration mainly on offices.

Last week, Wells Fargo (WFC.N), opens new tab CEO Charlie Scharf estimated that the US banking giant could write down $2 billion -$3 billion on its CRE loan portfolio over the next 3-4 years while it was provided for.
Both Flagstar and Fifth Third did not respond to the request for comment. Some of them did not answer in the negative, they just did not answer.