The second-quarter results of U.S. banks have revealed a concerning trend of boosted provisions for credit losses. This increase is primarily due to deteriorating commercial real estate (CRE) loans and the impact of high interest rates, which have sparked fears of potential defaults. Among the banks affected, M&T Bank is taking steps to reduce its exposure to the troubled CRE sector. By repositioning their balance sheets to focus more on commercial and industrial lending, these banks are striving to build up their capital reserves in an effort to weather the storm.
Struggles in the Office Loans Sector
Over the past year, office loans have been hit the hardest as a result of buildings remaining vacant due to the widespread adoption of remote working models post-pandemic. This shift has adversely affected landlords who are struggling to repay mortgages. Additionally, the options for refinancing these properties have been limited by the prevailing high interest rates. BankUnited, which has one of the largest CRE exposures by loan volume, disclosed that office loans made up 30% of its total CRE loan book. Consequently, the office portfolio allowance for credit losses at the bank climbed to 2.47% as of June 30th, indicating a significant increase from the prior quarter.
In addition to the challenges faced in the office loans sector, multi-family commercial loan portfolios are also showing signs of strain in major markets such as New York and Florida. Rent control regulations have played a significant role in exacerbating these issues, particularly for smaller U.S. lenders. Jeff Holzmann, COO at RREAF Holdings, highlighted that prolonged elevated interest rates have begun to expose weaknesses in the system. The depletion of interest reserves over time has left lenders with limited options, resulting in the need to write down or write off certain loans or positions.
KeyCorp saw a rise in net-charge offs to average loans for CRE in the second quarter, along with an increase in non-performing office loans. Bank OZK also raised its total allowance for credit losses significantly, indicating a cautious approach to managing potential risks. Blake Coules, CRE industry practice lead at Moody’s, emphasized the need for banks to thoroughly scrutinize their CRE portfolios. Detailed analyses, focused on specific areas of exposure, and multi-scenario strategies are essential for effectively mitigating risks. Broad generalizations may indicate that a bank has not fully grasped the challenges at hand.
Despite the mounting pressures stemming from deteriorating CRE loans, U.S. banks are not resorting to panic selling tactics. Instead, they are allowing these loans to run off the balance sheet naturally. There were concerns that regional banks might engage in distress sales of toxic assets, following the troubles faced by New York Community Bancorp earlier in the year. However, analysts predict that banks might opt to wait for potential interest rate cuts by the Federal Reserve before considering a sale of their loan books. Fed Chair Jerome Powell acknowledged that CRE risks would persist for years and assured that regulators were monitoring the situation closely to support smaller banks in managing these challenges. Washington Federal CEO Brent Beardall emphasized that despite the uncertainties, the sky is not falling in terms of CRE loans. Regions Financial and Fifth Third also reassured stakeholders of their cautious approach towards managing stress in the multi-family portfolios and office CRE originations, respectively.
Overall, the implications of deteriorating commercial real estate loans present a complex and challenging landscape for U.S. banks. While the road ahead may be rocky, strategic measures and a proactive stance towards risk management will be crucial for navigating these turbulent times in the financial sector.
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