US banks have jacked up commercial real estate credit loss allowance ratios by nearly a third over the past year as they start absorbing losses on office loans and contend with emerging questions about the multifamily sector.

Reserves to commercial real estate (CRE) loans were 1.56% across the industry in the fourth quarter of 2023, 4 basis points higher than the previous quarter and 33 basis points higher than the year prior, according to data from S&P Global Market Intelligence. Those were the biggest increases by far across individual loan categories for which regulatory data is available, with the overall credit loss reserve ratio on the same basis down 1 basis point from the previous quarter and up 11 basis points from the prior year to 1.81%.

New York Community Bancorp Inc.'s recent troubles, which included a large reserve build driven by loans backed by office and multifamily properties, reignited concerns about CRE exposure. The KBW Nasdaq Regional Banking Index fell 6.7% in the first quarter this year, though the KBW Nasdaq Bank Index, which comprises large-cap names, gained 8.2%. Large banks have substantial CRE portfolios, though they generally make up much smaller proportions of their loan portfolios than at small banks.

After the reserve builds, however, many banks have expressed confidence that they are prepared for write-offs headed their way, and that strains in multifamily will come nowhere close to the pain in the office sector. "I think we will eventually use the reserve, not replenish the reserve as we go through this," Wells Fargo & Co. CFO Michael Santomassimo said in February.

Biggest builds

While New York Community's reserve build drove it to a net loss in the fourth quarter of 2023, five other banks on major public exchanges posted bigger year-over-year increases in CRE allowances, including Wells Fargo.

Citigroup Inc. and Citizens Financial Group Inc. were just behind New York Community with year-over-year increases in CRE allowance ratios of 80 basis points each. A number of these banks also posted increases in CRE delinquency ratios that were well above the median, led by Wells Fargo with an increase of 351 basis points to 5.0%.

Analysts anticipate further reserve builds at New York Community, which stands out for its large exposure to rent-controlled apartment buildings.

By contrast, consensus forecasts do not anticipate significant builds at Citizens Financial this year or next year.

Regarding maximum possible losses on office loans, "we've expressed that in our reserves at 10.2%," Citizens Financial Chief Risk Officer Richard Stein said in March, adding that the bank is engaging in an extensive workout process and expects charge-offs to peak possibly toward year-end or into 2025.

"Multifamily is a different dynamic because vacancies are still really low," Stein said. "Absolutely, there's some pressure with higher rates and higher operating costs, but we view those as transient."

"We believe losses will continue to show up in bank results, as leases roll and banks have ample time to work through potential risks," Jefferies analyst Ken Usdin said in a March 28 note on large-cap and mid-cap banks. "At the same time, we believe the trajectory will be manageable and manifest gradually over an extended period."

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The long view

Even with the builds, CRE allowance ratios are still below levels reached early during the pandemic, when concern centered on sectors like retail and hotels, and just about where they were in 2013, under a previous set of accounting rules, when CRE net charge-offs were well on their way to recovering from a devastating spike during the Great Financial Crisis.

Broadly, bank economists expect that CRE losses will not spiral out of control, and that fallout from the sector will not derail firming conviction that the economy will achieve a soft landing as readings on factors like employment remain strong.

"Banks knew this was going to be bad [and] they prepared for things being bad, and especially on office," said Simona Mocuta, the chief economist at State Street Global Advisors, and the chair of an American Bankers Association advisory committee made up of 16 senior economists at large banks, at a March 28 briefing on the group's latest forecast. CRE has been a focus of the group for some time, but problems in the sector are not "progressing or intensifying beyond what the expectations had been."

In contrast to the office segment, most CRE sectors are in good shape, Mocuta said. Among the committee, "the sense was that we are not as far off reaching a bottom" in terms of commercial property price declines."