The second-quarter results of U.S. banks have revealed a concerning trend of increased provisions for credit losses, driven by deteriorating commercial real estate (CRE) loans and high-interest rates. In response to this, regional lenders like M&T Bank are gradually reducing their exposure to the troubled CRE sector and repositioning their balance sheets to concentrate on commercial and industrial lending to build capital.
Office loans have been severely impacted over the past year as buildings continue to remain vacant due to the adoption of remote working models in the post-pandemic era. This downturn has led to landlords struggling to repay mortgages, with limited options for refinancing properties due to higher rates. BankUnited, with a significant exposure to CRE, reported that office loans accounted for 30% of its total CRE loan book. The allowance for credit losses in the office portfolio at BankUnited climbed to 2.47% as of June 30, indicating a worrisome trend in the sector.
Multi-family commercial loan portfolios, primarily handled by smaller U.S. lenders, are showing signs of strain in major markets like New York and Florida due to rent control regulations. The COO at RREAF Holdings emphasized that cracks are starting to appear in the industry, especially after an extended period of elevated interest rates. Lenders are now facing challenges as reserves are depleted, forcing them to consider writing down or writing off loans.
To address the growing risks in the CRE sector, banks like KeyCorp have reported an increase in net-charge offs to average loans for CRE. It is crucial for banks to rigorously scrutinize their CRE portfolios, communicate areas of exposure, and develop multi-scenario strategies to mitigate the risks effectively, according to industry experts like Blake Coules from Moody’s. Broad asset classes or geographic locations should not be the sole focus of analysis, as a more detailed approach is necessary to tackle the challenges.
Despite the challenges in the CRE sector, recent earnings reports indicate that lenders are not resorting to panic selling or aggressive disposal of their CRE loans. Instead, some banks are allowing these loans to naturally run off the balance sheet. This approach contrasts with expectations of distress sales triggered by earlier events this year, suggesting that a more cautious and measured approach is being adopted by banks in handling their CRE assets.
With expectations of a potential cut in interest rates by the Federal Reserve later this year, banks may hold off on selling their loan books in anticipation of higher asset prices. Fed Chair Jerome Powell has highlighted that CRE risks will persist for years, emphasizing the need for banks to manage these risks effectively. While challenges in the CRE sector are significant, reports from banks like Washington Federal and Regions Financial indicate a belief that stress in multi-family portfolios may be temporary, pointing towards a more optimistic outlook in the long run.