Commercial real estate issues continued to weigh on US banks' first-quarter earnings results.
Commercial real estate (CRE) has become a source of credit quality concern as higher Federal Reserve interest rates have pressured borrowers facing maturities, and persistent work-from-home trends have led to weak demand for office properties. The pressure on CRE books increased in the first quarter with several banks reporting deterioration in credit quality metrics in their CRE portfolios.
Deteriorating CRE credit quality
PNC Financial Services Group Inc. reported a 9% increase in nonperforming loans during the first quarter, largely due to office. Of the $200 million increase, $188 million came from the company's CRE book, and $150 million of that came from office loans, CFO Robert Reilly said during the company's first-quarter earnings call.
The increase was an "expected" outcome given the occupancy and rate challenges inherent to CRE, Reilly said. Depending on specific markets and buildings, some office properties have lost 40% of their value or more with a high degree of variance, Chairman and CEO William Demchak said. As the company works through office loans, it has also seen a variance in recoveries, anywhere between 75 cents on the dollar to whole value, Demchak said.
"Your eyes aren't lying to you when you look out and see vacancies," the CEO said.
Meanwhile, U.S. Bancorp reported an approximately 20%, or $292 million increase, in nonperforming assets (NPAs) to $1.79 billion during the first quarter. The increase was due to continued stress in the company's CRE office portfolio and another "idiosyncratic" commercial loan, CFO John Stern
To prepare, U.S. Bancorp has reserved "aggressively" for CRE office loans, Dolan said. At the end of the first quarter, its reserve ratio for overall CRE was 3.1% while office reserve coverage was 10%.
At Bank of America Corp., commercial net charge-offs increased by $191 million due to CRE and office, including charge-offs on 16 office loans, CFO Alastair Borthwick said during the company's first-quarter earnings call. The company upped its reserves in response, and now one-third of its office book is considered reservable criticized.
"We believe the losses on these office properties have been front-loaded and largely reserved," Borthwick said. "We expect the losses to move lower in the second quarter and we expect a notable decline in the second half of the year, absent any material change in expected real estate prices."
F.N.B. Corp.'s criticized CRE office loans increased to 11% in the first quarter, from 9% in the linked quarter. The increase was due to a single credit the company underwrote at a 52% loan-to-value and fixed through a swap at 4.5%, Chief Credit Officer Gary Guerrieri said during the company's first-quarter earnings presentation. The loan is "not a concern," and F.N.B. Corp. has already extended it for another five years, Guerrieri said.
"They had one tenant move out. They're working on replacing that, but we felt it appropriate naturally to replace that in a rated credit situation," he said.
Bringing down CRE exposure
As CRE credit quality concerns continue to weigh on the industry, several banks are actively working to decrease exposures.
F.N.B.'s office CRE book balance shrank by $15 million due to payoffs. The company plans to be conservative with the office portfolio levels moving forward.
"With the performance of it, where we sit today at those very low levels, we'll continue to be aggressive around it and manage it appropriately," Guerrieri said.
Likewise, executives at Valley National Bancorp and Zions Bancorp. NA detailed efforts to manage their CRE concentrations.
Zions' criticized CRE loans increased to 7.8% in the first quarter from 5.3% in the linked quarter. Classified CRE loans rose by 40 basis points sequentially. Given the uptick and stress the office and multifamily segments are seeing, Zions is cautiously managing its CRE concentrations, COO Scott McLean said during the company's first-quarter earnings presentation.
"Compared to some of our peers, we've been very disciplined about hold levels," McLean said. "Concentration management, particularly as it relates to hold levels, is really important going into a time like this."
As part of the cautious posture, the company raised its reserves quarter over quarter, and its allowance for credit losses accounted for 2.3% of its CRE loans during the first quarter.
"We'll see some challenges probably in the office portfolio over time, but we continue to believe that we're very well reserved for what we think are our manageable losses in the future," Chief Credit Officer Derek Steward said.
During Valley National Bancorp's first-quarter earnings presentation, Chairman and CEO Ira Robbins acknowledged that Valley National's significant CRE concentration had caused volatility in the company's valuation that is not sustainable. At the end of the first quarter, 48% of Valley National's total loans were in CRE, with office loans accounting for 10% of the company's CRE portfolio. The company's stock price has fallen 34.01% year to date as of market close on April 29.
"As an organization, we need to begin to reduce what that macro CRE concentration is," Robbins said.
The company also saw an uptick in criticized and classified CRE loans in the quarter and there could be further rises in the future due to current expected credit loss methodology, but "it does not mean you're going to have a loss associated with that," Robbins said.