By Matt Tracy and Saeed Azhar
(Reuters) - Some of the largest U.S. banks singled out office commercial real estate on Friday as an area of growing concern, with property values falling and more borrowers defaulting on their loans amid rising interest rates and a slowing economy.
Faced with questions from analysts about their exposure to commercial real estate (CRE) and potential of losses, executives at Wells Fargo (NYSE:WFC) & Co, Citigroup Inc (NYSE:C) and JPMorgan Chase & Co (NYSE:JPM) said conditions were getting worse for the sector.
"Weakness continues to develop in commercial real estate office," Wells Fargo Chief Executive Charlie Scharf said on a call with analysts. The bank set aside an additional $643 million in the first quarter for credit losses, mainly driven by expectations of higher CRE loan losses.
Stress in the commercial real estate sector could have broad implications for banks and the economy, as losses emanating there can tighten credit availability and exacerbate a downturn.
JPMorgan Chief Executive Jamie Dimon said he expected tighter lending conditions, most of it around “certain real estate things” and that “increases the odds of a recession.”
Banks represent 54% of the overall $5.7 trillion CRE market, with the small lenders holding 70% of CRE loans, according to Citigroup analysts. More than $1.4 trillion in U.S. CRE loans will mature by 2027, with some $270 billion coming due this year, according to real estate data provider Trepp.
Loans backed by offices make up the biggest share of the maturing debt load, followed by multifamily and retail properties. The question now facing many borrowers is whether they can refinance or restructure loans to avoid default, bankers and analysts said. Older properties with high vacancies face the greatest refinancing challenge, they said.
"Office properties are currently facing the greatest refinancing risks" as companies reassess their needs, said John Guarnera, an analyst at RBC BlueBay Asset Management.
MAJOR CITIES
Bankers and analysts said the greatest stress in the office sector is likely to be felt in major cities such as San Francisco, Los Angeles, New York and Seattle.
"The regions with the highest level of office stress are located in the Northeast and tech-heavy West Coast," while southern cities have a lower share of risky loans, said Stephen Buschbom, research director at Trepp.
As the epicenter for the technology industry downturn, California's CRE market has been hit hard. San Francisco and Los Angeles had an average office vacancy rate of 21.6% in the first quarter, according to data from Cushman & Wakefield (NYSE:CWK). Loans for San Francisco offices now face the highest risk of default of all U.S. metro areas, according to Trepp.
A subsidiary of asset manager Brookfield Corp, for example, defaulted in February on $783 million in loans linked to two Los Angeles buildings, a filing showed. Citigroup and Wells Fargo were among the initial lenders.
Citigroup and Wells Fargo declined to comment for this article. Brookfield did not respond to a request for comment.
On an analyst call, Wells Fargo Chief Financial Officer Mike Santomassimo said the office market was showing "signs of weakness due to lower demand, higher financing costs and challenging capital market conditions."
“While we haven't seen this translate to meaningful loss content yet, we expect to see more stress over time,” he said.
PNC Financial Services Group Inc (NYSE:PNC) Chief Financial Officer Robert Reilly said its team was reviewing each asset in its office portfolio.
The lender was stress testing property performance to “set realistic expectations” and had “significantly discounted" income levels and property values "across the entire office book,” he said.