Credit Quality on Office Bank Loans Continues to Drop

S&P Global Market Intelligence has released a report showing that office remains a tale of two markets.

The gap between Class A on one side, as well as Class B and Class C on the other, has only increased over time. The most noteworthy sign is that tenants consider the state of a landlord’s balance sheet and willingness to invest capital in building improvements. The former exhibits worry that a landlord is a going concern, which is also an important consideration for lenders. The latter is a statement of wanting a “good” office property to remain so.

But it’s important to remember what Class A represents, as there aren’t hard-and-fast definitions. Early this year, Cushman & Wakefield estimated that the top part of the market comprised 10% to 15% of total office inventory. That raises the question of what percentage of bank office loan portfolios might be in real trouble. It’s mathematically unlikely that all banks have largely lent to overwhelmingly top-quality stock.

The S&P Global report went further into the question of office, looking at “elevated stress in office loan portfolios.” It put together a table of data at “select” banks, so it’s impossible to discern from the list of 34 the state of the nation’s banking system. However, the information gives some clues as to the amount of uncertainty.

The banks are rated by “office exposure balance for credit quality ratios.” They run from the top, Wells Fargo, at $30.5 billion, to the bottom figure of several banks that have $500 million (Berkshire Hills Bancorp, Commerce Bancshares, and First Financial Bancorp). The table shows that a percentage of office loans are non-performing or criticized. Then there is the portion of office reserves. Not all banks have data in all categories.

Start with Wells Fargo. Of the $30.5 billion office exposure, 10.3% are non-performing, with the number of criticized loans being unavailable. Office reserves are 7.9%. Second is Bank of America, with $17.4 billion in exposure. Of that, 12% are non-performing and 32% are criticized, although reserves aren’t available.

Third is PNC Financial Services Group, which has $7.8 billion in exposure, 10.5% non-performing, 26.4% criticized, and reserves of 9.7%. Trust Financial Corp. has $5.2 billion in exposure, 5.5% non-performing, no number for criticized, and 9.7% in reserves. Fifth is M&T Bank Corp., with $4.6 billion, 3.2% non-performing, 25.2% criticized, and no number for reserves.

S&P Global pointed out that Citizens Financial had increased its portfolio reserve coverage to 10.6% of office loans and said that level assumed peak-to-trough property value declines of 71% and an expected 24% default rate.

As of 2024 Q1, the number of banks exceeding 2006 CRE loan concentration guidance is a total of 504. Of those, 339 feature construction and development loans totaling at least 100% of risk-based capital and 258 with CRE loans totaling at least 300% of risk-based capital and 36-month CRE growth of 50% or higher. Risk-based capital refers to the minimum capital requirements set by regulators.

“Criticized loans have risen off historical lows, but the sector has not yet seen a corresponding increases in nonperforming assets,” S&P Global wrote. “This signals that banks are paying closer attention to potential challenges within their loan portfolios and trying to get ahead of the curve as opposed to sitting back and waiting for the loans to turn nonperforming.”

To what degree “extend and pretend” is playing is unclear. However, some large banks have been offloading parts of their CRE portfolios as they move away from this strategy.