If there was one thing that US bank investors wanted more information on in the latest earnings season, it was how exposed firms were to the troubles in commercial real estate (CRE). And banks generally complied, dripping out more data than they once did. For some this was the third season in which they had done so, meaning that a meaningful picture is starting to emerge of where exposures lie and how risky they are.
There was a timely reminder earlier this week of the pressure on the sector, as credit ratings agency Moody’s unveiled ratings downgrades on 10 small banks as well as putting some of the big super-regionals on review for downgrade or switching its outlook from stable to negative. One of the drivers Moody’s cited was exposure to commercial real estate.
Euromoney has sifted through the quarterly earnings reports of a sample of 11 of the country’s super-regional banks, plus Wells Fargo and Bank of America for comparison, and plotted the highlights and lowlights.
By way of a caveat, it should be noted that the sector is infamous for its wildly varying degrees of nuance. Offices come in many types, and banks classify them differently. Many exclude owner-occupied properties from their CRE data, for example, on the basis that they present a radically different – and better – credit profile to those leased by landlords. Some exclude healthcare-related facilities.
The banks tracked in the charts below, and referred to throughout by the stock tickers, are: Bank of America (BAC), Citizens (CFG), Capital One (COF), Fifth Third (FITB), Huntington Bancshares (HBAN), KeyCorp (KEY), M&T Bank (MTB), PNC Financial Services (PNC), Regions Financial (RF), Truist (TFC), US Bancorp (USB), Wells Fargo (WF) and Zions Bancorp (ZION).
Biggest exposures
In absolute terms, Wells Fargo has by far the biggest exposure to CRE lending in our sample, at about $154 billion, more than double BofA’s $75 billion. Of the super-regional firms, US Bancorp ranks top, with $54 billion, followed by M&T Bank with $44.6 billion.
It is a similar pattern when looking at purely office loans, with Wells again top with $33 billion, but with PNC pipping US Bancorp among the super-regionals, with $8.7 billion.
What matters more than the absolute size of exposure, however, is the size relative to a bank’s overall balance sheet. On this metric, it is M&T Bank that looks the most weighed down, with its CRE exposure accounting for nearly 34% of its total loan book. The average for our sample is about 15%, and at BofA it is just 7%.
Narrowing down to just office exposures puts Citizens and Zions above M&T Bank, with offices accounting for just over 4% of all loans at Citizens, nearly double the average of 2.3%. But it is actually BofA that has the highest concentration of office loans within its CRE book itself, at about 25%, followed by PNC on 24%.
charts 3 & 4
Credit quality
Of course the real issue is credit quality, not sheer size. It should be little surprise that overall CRE non-performing loan (NPL) statistics broadly track exposures, with Wells again top with about $2.5 billion of CRE NPLs as of June 30. But M&T Bank comes next, despite being fourth for overall exposure.
That is duly reflected in M&T’s CRE NPL rate, which stands at about 3.4% and is the clear outlier in our sample. The average is 1%. For comparison, M&T’s overall NPL rate – for its entire loan portfolio – is about 1.8%. The average for our sample is 0.6%, meaning that CRE NPL rates are trending about twice that of other loans.
charts 6 & 7
But M&T’s rate has at least not been worsening: it is flat to where it was at the end of 2022. That is quite a different pattern to others, many of which have seen sharply worsening CRE NPL data. The biggest change over those six months was at Truist, where CRE NPLs rose from $82 million at the end of 2022 to $291 million at June 30, 2023. But a clutch of other firms have seen similar increases.
Plotting the NPL rates against the CRE concentration data shows that – apart from M&T Bank – some of the highest concentrations also have the lowest NPL rates, and are also some of the smallest books in absolute terms.
Even with CRE – and the office sector in particular – having been an area of intense focus this year, banks are still not consistent about their reporting of office-related data. Not everyone reports office NPLs, for instance, making those that do into something of an unwelcome barometer for the whole sector.
Wells Fargo was the canary in the coalmine back in the first quarter 2023 earnings season, when it reported a leap in office NPLs from $109 million at the end of 2022 to $725 million as of March 31, three months later. It followed that up with another jump in its latest results, to $1.5 billion. BofA also saw a doubling of office NPLs between the first and second quarters of 2023, but did not report the end-2022 figure.
Office NPL rates, for those that do report them, are considerably uglier than other classes, with an average of nearly 4.5%.
NPLs are a closely watched metric, but monitoring criticized loan levels is a better indication of potential trouble brewing. Criticized loans are those that banks judge to be worthy of concern even if they are still performing, and are judged according to a bank’s internal modelling based on a borrower’s creditworthiness, their ability to service the loan or an assessment of the value of the underlying property.
Banks are generally good at reporting these for CRE, and once again M&T Bank tops the chart, with more than $8 billion of criticized loans, for a rate of nearly 19% of its book. The average for our sample is about 10%.
charts 12 & 13
KeyCorp has seen the biggest percentage jump in criticized CRE loans since the end of 2022, but it also has almost the lowest rate in terms of its overall CRE book. That is not the case at Citizens, where criticized loans are up more than 75%, for a rate of nearly 15%, the second highest.
Reserves
Banks build reserves against predicted losses, and our cohort has been doing just that, with the aggregate allowance for the group rising from $8.6 billion at the end of 2022 to $11 billion now, an increase of 28%. Truist has seen the biggest percentage increase, up 89% from the end of 2022. As noted in the charts above, it has nearly the lowest proportion of CRE loans in its overall book, at just 9%, but also a relatively high NPL rate of just over 5% and a criticized rate of 11%.
charts 15 & 16
CRE allowance coverage rates average out at 2.2% across our sample, and range from 1.4% at Zions to 3.4% at Huntington and PNC. Office allowances are still very patchily reported, but they can be as much as triple the broad CRE rates.
charts 17 & 18
So what?
In a note on Thursday, analysts at Stephens Research extrapolate from Citizens’ allowance for credit loss methodologies to estimate hypothetical office loan losses at the super-regional banks of $3.7 billion, on the basis of 18% loan default frequency and 50% severity, the high end of Citizens’ assumptions for office loans, and translating into a roughly 9% loss rate for the super-regionals as a whole.
The analysts’ sample is slightly different to our groupings in the charts above – it excludes Capital One but includes Comerica. It also assumes an average allowance of 5% for office loans, which is arguably a slightly low estimate on the basis of the figures we have collated above, making the projected net loss greater than it might otherwise be.
But what they conclude is that consensus pre-provision net revenues for the third quarter of 2023 are more than seven times the estimated $1.7 billion of office loan losses that would be left over after $2 billion of allowances.
That is a fairly upbeat picture, but one that also reflects the recent findings of the latest Federal Reserve stress test of the biggest banks, in late June, which showed them well able to withstand a CRE downturn. The severely adverse scenario in the test included a 40% fall in CRE valuations – with that fall concentrated on the weakest properties, like offices.
Across the 23 banks that were subject to the test the average projected CRE loan loss rate was 8.8%, a total of $64.9 billion.
That is down from 9.8% last year, but the office loss rate in this year’s test was about 20%, the Fed said, and it noted that the last few stress tests had showed higher projected office loss rates than peak losses in the global financial crisis. The Fed estimates that the banks tested hold about 20% of total office and downtown retail CRE loans.
The biggest potential CRE loss rate this time around was at Goldman Sachs, with 16%, while Citizens was highest among the super-regionals, at 12.4%. But the Fed was reassured that all the banks tested would have enough capital to withstand its worst-case scenario.
