Charge-Offs of Bank CRE Office Loans Surge

Understanding how well or badly the office market has been doing has become a challenge, at least when closely watching the daily news cycle.

But data has been accumulating and building a better picture of what has been happening. Trepp released its September 2023 bank research note. and from the perspective to banks lending to the office sector, things aren’t looking good.

“Net charge-offs and delinquency rates for bank-held commercial real estate (CRE) loans increased in the second quarter, with all major commercial property types showing greater distress,” Trepp wrote. “Lender concern about risk, indicated by criticized loan rates, increased across multiple regions for most property sectors. The pace of origination volume has slowed dramatically, with Q2 2023 commercial mortgage origination volume at only about 60% of the pre-Covid average quarterly origination volume in 2019.”

Trepp looked at bank balance sheet loan-level data. The source is important because aspects of bank business are publicly available and gives a view of the world that isn’t tied to CMBS. The specific data set available to Trepp is $160 billion in a “diverse set of loans” from multiple banks.

More specifically, Trepp was looking for charge-off actions, in which the bank absorbs future losses onto its balance sheet. Those charge-offs don’t get added to delinquency reports to regulators because they’re already fiscally recognized.

“The net charge-off amount for the office sector more-than-tripled consecutively in the previous two quarters, from $49 million in Q4 2022 to $149 million in Q1 2023 to $459 million in Q2 2023,” Trepp said. The lodging and multifamily sectors have also seen increases in charge-off amounts in recent quarters.”

Divide the net charge-off amount by the total loan balance for each type and the result is the net charge-off rate, which is a measure of how quickly charge-offs are happening. Only lodging also reached the height of office charge-offs. Trepp attributes this to the lodging sector historically having the lowest outstanding loan balance of the different property types. That makes the charge-off amount larger than for other types because the denominator is smaller, pushing the ratio up.

“Most property types saw stabilization or slight decreases in outstanding balances from the first to the second quarter of 2023,” said Trepp. “Multifamily stands out as seeing an uptick in outstanding bank loan balance, while we also see some large roll-off in the industrial sector, as existing loans are paid off and new loan origination has had stunted growth.”

But for all that, there’s a jump in delinquency and default rates. The two have returned to the heights of 2020 Q4. “The total delinquency rate rose 12 basis points from 1.03% in the first quarter to 1.15% in the second quarter of 2023,” they said. “The serious delinquency rate, or the non-current loan rate, experienced an uptick of 17 basis points, increasing from 0.78% in Q1 to 0.95% in Q2.”