Growth in commercial real estate delinquencies slowed for the second consecutive quarter as high interest rates continue to pressure borrowers while banks emphasize that stress remains concentrated in the office sector.

Overdue commercial real estate (CRE) loans across US banks increased 10 basis points sequentially to 1.25% in the first quarter, according to data from S&P Global Market Intelligence. While that represents a new cycle high, the increase was less than the increase of 11 basis points in the fourth quarter of 2023 and the increase of 21 basis points in the third quarter of 2023.

CRE exposure is being scrutinized by regulators. Loan growth has slowed sharply amid tighter lending standards and higher rates that have hurt borrower demand and property values and transaction volumes. However, many banks have built sizable loss reserves for office, and net charge-off rates declined sequentially across CRE, multifamily and construction loans.

"Although higher interest rates continue to challenge commercial real estate, there are plenty of reasons for cautious optimism that a turnaround is on the horizon," Wells Fargo economists said in a May 28 note. They pointed to factors like a decline in construction, with industrial, retail and office starts at their lowest level since 2012, which is curbing available space, and a strong economy that is supporting household formation and CRE demand.

"What's more, the slower pace of price declines is a sign that the air of pessimism surrounding the asset class is beginning to dissipate as less restrictive monetary policy comes closer in view."

– Access a spreadsheet with the data in this article. – Set email alerts for future Data Dispatch articles. – Download a template to generate a bank's regulatory profile.

Sluggish lending

Overall year-over-year CRE loan growth across the industry was 3.0% in the first quarter of the year, a bit higher than 2.9% in the preceding quarter but well below the most recent peak of 12.1% in the third and fourth quarters of 2022.

Multifamily growth did accelerate to 4.5% in the first quarter of 2024 from 2.1% in the fourth quarter of 2023, though it remained well below the recent peak of 17.7% in the third quarter of 2022.

Some multifamily markets around the US have been strained by heavy construction. Nationally, multifamily net absorption — the rate at which tenants occupy new space — hit its strongest pace in the first quarter since 2021, according to the Wells Fargo economists. The trend reflects a strong labor market and healthy household formation, in addition to "the recent jump in mortgage rates, which have renewed affordability pressures in the single-family market" for home purchases, they said.

Concentration

The number of banks exceeding regulatory guidance for CRE concentration fell for the fourth consecutive quarter to 505, the lowest level since the third quarter of 2021.

Some banks have sought to reduce concentration through loan sales. Valley National Bancorp shed $151.0 million of CRE loans and $45.6 million of construction loans in the first quarter through participation agreements with Bank Leumi le-Israel BM.

Valley National bought US-based Bank Leumi Le-Israel Corp. in 2022 and entered into a participation agreement with its former Israeli parent in a transaction that it said would reduce its CRE concentration.

In May, WaFd Inc. agreed to sell $3.2 billion of multifamily loans it picked up as part of its February acquisition of Luther Burbank Corp.

Biggest banks

CRE loans increased by a median 1.2% over the year prior at the 20 banks with the biggest CRE portfolios.

That includes a 29.3% increase at JPMorgan Chase & Co., driven by its acquisition of the failed First Republic Bank.

Most of JPMorgan Chase's portfolio is in multifamily, where it focuses on properties with below average rents in supply-constrained markets, Douglas Petno, co-head of global banking commercial and investment bank, said at an investor day on May 20. The bank has a credit reserve allowance covering about 8% of its office portfolio.

"While charge-offs are [forecast] to be higher year over year, we expect them to be manageable and primarily concentrated in office," Petno said.