These numbers show that banks' risk from office real estate has been exaggerated

By Philip van Doorn

Christopher Marinac of Janney Montgomery Scott says banks are providing a lot of information that is being ignored

By now you have probably seen myriad headlines about an alarming level of risk that banks are facing from potential losses on their portfolios of loans secured by office buildings. But there are fallacies in many media reports.

The problem centers on the decline of market values for office buildings in the U.S., as a change in working habits exacerbated by the COVID-19 pandemic is leading to companies deciding that they don't need to lease as much space as they have in the past. This means higher vacancies, especially for older buildings, which has helped to reduce their market value. And as loans secured by office buildings mature, borrowers might not have enough collateral to renew the loans.

Altogether, this scenario leads to some frightening figures that don't take an important factor - time - into account.

In a recent article listing investment newsletters' "favorite conservative bank stocks," Mark Hulbert linked to a study led by Rebel Cole, a finance professor at Florida Atlantic University's College of Business, who wrote: "The imminent refinancing of loans, combined with more commercial properties selling at a discount relative to pre-pandemic values, has exposed vulnerabilities in the banking system not only to commercial real estate mortgages, but also to commercial real estate construction loans and unused commitments to fund commercial real estate mortgages and loans."

Cole listed 66 banks with ratios of total commercial-real-estate (CRE) loans to total equity exceeding 300%. "Any ratio over 300% is viewed as excessive exposure to CRE, which puts the bank at greater risk of failure," he wrote.

But most of these commercial-real-estate loans aren't maturing immediately. The maturities are spread out over the next several years. Additionally, Cole's data comes from the Federal Financial Institutions Examination Council Central Data Repository's database, with numbers culled from banks' regulatory call reports. These uniform reports are a convenient tool for analysis, but they don't break out loans secured by office properties. And that is the category of commercial real estate under the most pressure.

A better set of data and estimates for Banks' office real-estate exposure and risk

Christopher Marinac is the director of research at Janney Montgomery Scott. He joined Janney when it acquired FIG partners in 2019. Marinac was a co-founder of FIG, an investment bank that specialized in community banks.

Using data from banks' filings with the Securities and Exchange Commission, Marinac estimated on Monday that U.S. banks with total assets of at least $50 billion had $360 billion in loans secured by office real estate, or 4.3% of these banks' $8.4 trillion in total loans. He called this a "conservative" estimate for office exposure in his report.

During an interview with MarketWatch, Marinac explained that even though the banking regulators still weren't asking banks to break out office loans from their total CRE loans, the SEC had requested this level of detail from the publicly traded banks and bank holding companies last year.

"They wanted more detail. They hinted they were worried about office real estate. The banks all responded," he said.

Going back to that 4.3% estimate for office real-estate exposure within loan portfolios, consider the following:

Those 4.3% of total loans don't all mature at the same time. Their maturities are spread out over a period of years. If an office property securing a loan has lost significant market value, the lender knows about it well in advance of the loan's maturity. This enables the lender to set aside reserves for that loan before it comes up for renewal. A bank will place even a loan whose payments are current into a "criticized" category if there is a problem with the collateral, which leads to them setting aside the specific reserves. And bank examiners make sure that they do it. There is still some value in the office property, and the loan was most likely made for considerably less than the office property's value was at that time. So there is a cushion for the lender.Most of the banks are profitable. This is another factor enabling them to set aside specific reserves for potential problem office loans.

All of these factors mean that a snapshot showing credit exposure to capital isn't a fair way to analyze the problem.

In his report on Monday, Marinac estimated that under Janney's "severely adverse loss scenario," 40% of the office loans for U.S. banks would become "problem loans," and that there would be a 60% loss rate on those loans. This would equate to a "24% possible loss content" for the office loans for the industry.

This would work out to $86.4 billion in losses for U.S. banks with total assets of $50 billion or more. "These national and regional Banks havesolid Reserves already in place AND their PPNR (pre tax, pre provision net revenue) remains quite healthy," Marinac wrote, and the capital letters for the word "and," were his.

During the interview, Marinac said that one of his "great frustrations is companies are putting out more information than ever, and nobody is reading it. So there is a lot of focus on what the ratings agencies have said, or some person. But nobody pays attention to what people are putting out."

Again, a reason for this is that the standard uniform call-report data still doesn't break out particular CRE categories. One must take the extra step of compiling information from the quarterly (or annual) SEC filings.

Marinac said he hoped the Federal Deposit Insurance Corp. would change the call report to require additional information about the makeup of banks' CRE portfolios, including maturity schedules by loan type. "I have asked FDIC to create a roundtable with outside analysts and the media, to improve the document. We moved through a crisis 15 years ago that gave us the need for more data."

For now, analysts need to sift the SEC reports if they wish to focus on office-loan risk.

Getting back to pre-provision net revenue (PPNR), this is a bank's profit before taxes and before it sets aside any money to cover potential loan losses. (The addition to loan loss reserves each quarter is called the "provision for loan loss reserves.") That feeds a set of estimates for some of the largest U.S. banks, provided Wednesday by Marinac in a "focus list." Bank OZK (OZK) is also on the list, even though it has less than $50 billion in assets, because there have been many media reports about its CRE loan exposure.

Since there are too many columns of data to fit on one table, we are splitting it in two. The first table shows the banks' total assets, ratios of total CRE to risk-based capital, percentages of loans secured by offices to total loans and loan loss reserves to total loans as of March 31.

The second table breaks down estimates of PPNR through 2026 and shows how these profits can cover potential office-loan losses for nearly all of these banks under Janney's adverse scenario.

Column headings are defined below the second table. The banks are listed alphabetically.

   Source: Janney Research (FIG Group), FDIC call reports and SEC filings. KEY adjusted for Medical Office (lower risk).   City                Ticker   TA ($bil)  All CRE to RBC  Office CRE % of total loans  Reserves % 
   Bank of America Corp.                                                                                                   Charlotte, N.C       BAC        $2,550             38%                         1.7%       1.37% 
   Bank OZK                                                                                                                Little Rock, Ark.    OZK           $36            357%                         8.0%       1.88% 
   Citizens Financial Group Inc.                                                                                           Providence, R.I.     CFG          $220            141%                         5.0%       1.61% 
   Comerica Inc.                                                                                                           Dallas               CMA           $80            194%                         1.9%       1.43% 
   Fifth Third Bancorp                                                                                                     Cincinnati           FITB         $214             72%                         3.0%       2.12% 
   Huntington Bancshares Inc.                                                                                              Columbus, Ohio       HBAN         $193            108%                         1.4%       1.98% 
   KeyCorp                                                                                                                 Cleveland            KEY          $185             85%                         0.8%       1.63% 
   M&T Bank Corp.                                                                                                          Buffalo, N.Y.        MTB          $215            202%                         5.0%       1.66% 
   New York Community Bancorp                                                                                              Hicksville, N.Y.     NYCB         $113            478%                         3.8%       1.56% 
   PNC Financial Services Group Inc.                                                                                       Pittsburgh           PNC          $562             83%                         2.4%       1.68% 
   Regions Financial Corp.                                                                                                 Birmingham, Ala.      RF          $154             93%                         5.0%       1.79% 

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06-15-24 0617ET

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