America’s regional banks continue to work on their commercial real estate portfolios, especially their office CRE loans. But strategies vary widely, hinging on how deeply they were into CRE to begin with or their overall corporate strategy. Some reports suggest that a recent jump in foreclosures means that the CRE crisis is entering the end game. But CRE can’t be tackled in a vacuum because the loans sometimes represent a part of a business relationship that the bank values for other reasons — a rich source of deposits, for example.
In June, the Office of the Comptroller of the Currency issued its latest Semiannual Risk Perspective, a report reviewing the agency’s collective concerns. Commercial real estate credit was the very first one mentioned:
“Credit risk is increasing. Commercial real estate sectors, primarily the office sector and some multifamily property types, are experiencing stress due to a higher rate environment and structural changes. Office and multifamily loans, particularly those with interest-only terms, set to refinance over the next three years pose additional risk.”
Not so long ago, much talk was devoted to “the maturity wall” in CRE and commercial mortgage-backed securities. An analysis of the CRE situation from Lord Abbett suggests that while the threat is real, it isn’t inevitable.
“The wall is a moving target,” wrote Harris Trifon, partner and portfolio manager at the firm. “Most lenders are willing to negotiate extensions of debt in exchange for more equity, better loan structure, and more recourse, among other items.”
Moving the Wall Amid a Confusing Economic Picture
Lord Abbett’s point was borne out time and again during second-quarter earnings briefings from super regional and regional banks in July. CEOs and other top officials stressed how much bankers and borrowers have been discussing properties under pressure and how borrowers have been anteing up to keep the loan relationship going.
“Borrowers have been anteing up to keep their loan relationship going.”
Daryl Bible, senior executive vice president and CFO at M&T Bank Corp., said more CRE loans are being modified and that the modifications resulting from negotiating with CRE customers was enhancing the bank’s position. The bank trades extra time for concessions from the borrower, such as added recourse on a loan that gives the bank better fallback.
“This is our history at M&T,” said Bible. “We work with our clients. If our clients support us, we’re going to support them.” Bible said the bank instituted a process to look at all CRE loans that are maturing “to get it right-sized to get it off the criticized loan list.”
Another frequent theme: How much regional banks’ top executives are watching inflation and the Federal Reserve’s hints and pronouncements about interest rates. Some told analysts that they are hoping for significant breaks on both fronts. But others think current challenges will run for multiple quarters yet.
Meanwhile, CRE challenges are happening at the same time that many banks are citing low loan demand, especially in the commercial and industrial loan category.
“Broadly, loan demand remains tepid, and the pricing environment remains competitive,” said Christopher Gorman, chairman and CEO at KeyCorp.
Gorman said KeyCorp hopes to see “stabilization and potentially some growth in the back half of the year. Our pipelines are building.”
Others already feel their pipelines are flowing again — or soon will be. “Pipelines are stronger than they were a year ago, certainly stronger than they were two quarters ago,” said John Turner, chairman, president and CEO at Regions Financial. Turner expects a pickup in loan growth in 2025.
“CRE volume remains challenged, driven by the higher-for-longer rate environment,” said Frank Holding, CEO at First Citizens Bancshares (acquirer of much of Silicon Valley Bank in 2023). “Deal volume is expected to remain muted during the second half of the year.”
Citizens Financial Group noted its key assumption of a coming shallow recession, with greater severity in certain sectors, including office CRE. Meanwhile, Harris Simmons, chairman and CEO at Zions Bancorporation, noted that, “There are some signs the economy is slowing a little bit, hopefully not in a way that will do a lot of damage.”
Some institutions are using the CRE crunch as a pivot to reduce concentration in those types of loans in order to focus more on commercial and industrial loans. In other cases, the type of CRE borrower favored is shifting.
At Valley National Bancorp, it’s a bit of both, as “future loan growth will likely be tilted towards C&I and owner-occupied CRE as new investor CRE originations remain well controlled,” said Ira Robbins, CEO.
From the archives: Charge-offs and Bigger Reserves: Inside the CRE Crisis at the Regional Banks
Citizens Financial Group Works on Office Cleanup
Citizens Financial Group has been dealing with cleanup in CRE, chiefly in the general office category, even as it has a medium-term plan to reduce the company’s CRE exposure, according to Bruce Van Saun, chairman and CEO.
Van Saun said much uncertainty remains for the office CRE market. “We’ve played it conservatively by having a big reserve and then just kind of letting the chargeoffs run through, while maintaining the reserve,” he said.
“We’re prepared for a slog here on office CRE that we’ve got our arms around.”
— Bruce Van Saun, Citizens Financial Group
“We’re prepared for a slog here on office CRE that we’ve got our arms around. We know what the maturity schedules are. We’ve got good people working with the borrowers to deliver good outcomes,” said Van Saun. As things turn around, the credit reserve can be reduced, “and we’ll reap a nice benefit when that happens,” he said. He said a Fed move to start reducing interest rates again would help.
John Woods, CFO, said that exposure is being worked down every quarter, but that “this is a multi-quarter, probably multi-year journey.” He said the bank was obtaining additional collateral and obtaining paydowns from borrowers where possible. According to Woods, the office CRE portfolio, which started at $4.2 billion, has been reduced to $3.3 billion. (Officials noted that the CRE portfolio overall grew significantly after the 2022 acquisition of Investors Bancorp.)
“Credit metrics are holding up fine outside of general office,” said Van Saun. Office CRE has been “lengthy,” and “will take several more quarters before we see improvement,” he said. Office CRE accounted for most of the bank’s quarterly increase in its allowance for credit losses.
One positive point for Citizens, he said, is that approximately 70% of the bank’s office CRE exposure is suburban versus central business district. He said losses due to defaults among suburban office properties have been about half of what the bank has seen among loans on properties in central business districts.
“The good news is that we have our arms around the issue and we don’t expect to see major surprises,” said Van Saun.
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New York Community Bancorp on the Comeback Trail
For NYCB, 2024 is a transition year as a new management team led by former Comptroller of the Currency Joseph Otting works to offload business lines that it deems extraneous to the company’s core strategies and to clean up the portfolio to return NYCB to profitability.
A key focus has been addressing problem loans, many of which are in the CRE portfolio. Toward that end NYCB hired a new head for its workout group. He is William Fitzgerald, EVP and head of workout-commercial. Fitzgerald most recently served as head of commercial real estate restructuring group at First Citizens Bank.
“We’re working to retain those borrowers where we have relationships, where they bring us deposits.”
— Craig Gifford, NYCB
A major goal for Otting is shrinking the bank’s exposure to CRE. At the time of the earnings briefing, the portfolio was about $45 billion, and Otting wants to slim that down to between $30-$33 billion. Otting said that one element of that workdown is payoffs of outstanding CRE debt. In the second quarter, half of that was actually among classified CRE loans. It’s a point of pride at the bank that among the classified loan payoffs the amounts paid were at par. (Overall, 2.1% of the CRE portfolio was paid off in the second quarter, with 4.2% of office CRE being paid off. Nearly all of the office CRE number included classified loans.)
One of the screens for continuing to bank a CRE customer is the depth of the overall relationship.
“As we have loans that are hitting reset dates and maturity dates, we’re working to retain those borrowers where we have relationships, where they bring us deposits,” explained Craig Gifford, CFO. However, he added, as borrowers who are “simply using our balance sheet” aren’t encouraged to stay as they near their reset dates. “We’re working to reduce our exposure to and our concentration on commercial real estate and so we’re helping those borrowers to find ways to move off the balance sheet.”
These kinds of issues have been surfacing since the bank has been reviewing its loan portfolios. This effort started with the largest credits, scrutinized in the first quarter. Otting said that after further examination the bank had been through 75% of the CRE portfolio overall, including 82% of the office loans and 80% of the multifamily loans. The loan reviews led to many appraisals of properties, which in turn led to increased charge-offs.
Not all loans identified as troubled are being worked out or paid off. Another strategy the bank has been exploring is reducing the amount of non-accrual loans through sales. Otting said that both sales of pools of loans and some large individual loans is being considered.
“While you never quite know exactly where the market will be, we do think we have a real opportunity to move a number of these assets off the balance sheet between now and the end of the year,” Otting said.