Overdue commercial real estate loans ticked up further as acute stress in the office sector continues to work its way through bank portfolios.

The delinquency ratio for commercial real estate (CRE) loans across US banks rose 16 basis points in the second quarter to 1.40%, according to data from S&P Global Market Intelligence.

CRE borrowers across property types are facing pressure from higher interest costs as loans mature, though a sharp decline in medium-term interest rates as Federal Reserve cuts near stands to provide some relief. Problems remain concentrated in offices where vacancy rates have soared and property values have plummeted. A number of banks with large office portfolios reported lifting loss reserves incrementally from already high levels.

The trajectory of property values remains uncertain while transaction volume remains low.

"CRE property prices were roughly unchanged at the end of July versus the end of June, lending some additional support to the notion that CRE prices are gradually stabilizing," BofA Global Research analysts said in an Aug. 23 report. "Price corrections have begun to moderate across all property types, although 'improvements' among multifamily and office properties were the least pronounced."

"Perhaps the most notable greenshoot is that the Federal Reserve now appears ready to begin easing monetary policy now that a downward path for inflation is more certain and the labor market is on less secure footing," Wells Fargo economists said in a Sept. 3 report.

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Weak loan growth

Year-over-year CRE loan growth across US banks slowed to 2.2% in the second quarter from 2.9% in the first quarter and a recent peak of 12.1% in the third quarter of 2022.

The slowdown reflects the recent drop in property values along with tougher loan standards.

Nonowner-occupied, nonresidential property loans, the largest CRE category, have led the way down, with year-over-year growth of 1.2% in the second quarter. Construction and development loans grew 2.0%, well off the pace of the recent peak of 16.4% in the fourth quarter of 2022.

Declining concentration

The number of banks exceeding regulatory guidance for CRE concentration fell for the fifth consecutive quarter to 482.

Provident Financial Services Inc. joined the banks exceeding the guidance in the second quarter after its acquisition of Lakeland Bancorp Inc. Regulators approved the deal with a number of conditions, including a $200 million capital raise, reflecting concerns over CRE.

Big banks

Among the 20 banks with the largest CRE portfolios, such loans fell by a median 2.1% year over year, with a dozen of them posting declines.

That list includes a 15.7% decline at M&T Bank Corp. unit Manufacturers and Traders Trust Co. The company said it is now a quarter or two away from its target for CRE exposure, and it posted a sequential decline in criticized CRE loans.

Valley National Bancorp unit Valley National Bank posted a 3.6% decline that brought it to its year-end target for CRE loans to total risk-based capital of about 440%, though that is still above regulatory guidance. The bank is targeting 400% over the intermediate term.