Nonperforming loans in the office sector increased as a percentage of total office loans in the third quarter for a majority of US banks in an S&P Global Market Intelligence analysis.

S&P Global Market Intelligence collected data for 38 banks with outstanding office exposure greater than $450 million at Sept. 30. Eighteen of those banks had data available for office nonperforming loans (NPLs) as a percentage of office loans and 11 reported sequential increases.

The Federal Reserve's interest rate hikes over the last year have made refinancing increasingly difficult for office property owners who originated loans at much lower rates and are struggling with persistent remote work trends. With billions in commercial real estate office credits scheduled to mature in the coming years, banks reported moving more office loans into the nonperforming category and reducing their exposure to the sector during the third-quarter earnings period.

Office NPLs rise

First Financial Bancorp.'s nonperforming office loans accounted for 36% of total NPLs, a larger portion than any other bank in the group. Office NPLs accounted for 5.7% of the company's total office loans, up 4.2 percentage points from the prior quarter. The company had two relationships totaling $27 million on nonaccrual status as of Sept. 30.

Nonaccrual loan balances rose during the period due to the downgrade of one office loan, on a property north of Cincinnati in the suburban Blue Ash area whose major tenant vacated the space during the quarter, President and CEO Archie Brown Jr. said during the company's third-quarter earnings presentation.

With billions in loans set to mature over the next few years, US bank office portfolios are likely to face ongoing pressure if rates remain high.

Bank of America Corp. alone has nearly $9 billion in office loans scheduled to mature by the end of 2024 and $9.4 billion in 2025 and beyond. New York Community Bancorp Inc. has $321 million in office loans that will mature by the end of 2024 and $3.1 billion in 2025 and beyond.

Banks draw down office lending

Some banks adapted to office lending challenges during the quarter by shrinking their office books. Of 38 banks in the analysis, 27 reduced their exposure to the sector in the third quarter, according to S&P Global Market Intelligence data. Eighteen of those with reduced exposure had declines of more than 1%, while nine (including Columbia Banking System Inc., which reported a 0.03% decline) had decreases of less than 1%.

Ten banks in the analysis increased their office exposure sequentially, and one reported flat exposure. The group median was a reduction in exposure of 1.0%, and the median office exposure as a proportion of gross loans was 4.4%.

Executives at Webster Financial Corp., which reported the second-largest reduction in office exposure in the group at negative 8.6%, said the company's office divestment in the third quarter was part of a $500 million reduction in exposure since the second quarter of 2022.

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The company's remaining office loans are "generally well secured," with no delinquencies, a low level of nonaccrual assets and a guarantee or reserve for almost two-thirds of the portfolio, President and CEO John Ciulla said during the company's third-quarter earnings presentation. The company does not have a dedicated timeline for reducing risk in its office book, he said.

"We're not really looking at a serial reduction in the exposure," Ciulla said. "Many of these loans are going to refinance fine, they're going to pay off fine."

Among all 38 banks in the analysis, Western Alliance Bancorp. reported the largest exposure increase at 13%. The increase in exposure was not a result of new office loans, however, and would have been a result of loan balance increases on existing loans, Chief Credit Officer Timothy Bruckner said during the company's third-quarter earnings presentation.

Suburban office loans not immune

Western Alliance's office portfolio is heavily concentrated in suburban areas, which can be less risky for commercial real estate than more densely populated, urban markets in the post-pandemic economy. The company's office portfolio is 87% suburban, the highest suburban exposure of any bank in the analysis that provided a precise value. Even so, office books concentrated in suburban markets were not necessarily safe from the broader pressure on the sector during the third quarter.

For example, Zions Bancorp. NA, which has an office portfolio that is 70% suburban, reported an increase in nonperforming assets mostly due to two suburban office loans in California. The credits suffered from "lease rollover issues," Chief Credit Officer Derek Steward said during the company's third-quarter earnings presentation.

"They were actually value-add properties where they weren't able to retenant as fast as the sponsor was hoping for," Steward said.