Peering through the window into US offices
Here’s a counter-intuitive bright spot for US regional banks, just in time for earnings season: they have less exposure to top-tier properties in the biggest cities.
Regional banks do more lending to offices deemed to be lower quality, including those located in second-tier cities, third-tier cities and the suburbs, as analysts from Goldman Sachs wrote this week. But this is probably a good thing for smaller banks.
Offices in the six biggest US markets — Boston, Chicago, DC, Los Angeles, New York, and San Francisco — have seen bigger declines in occupancy than smaller markets, the bank says, citing data from CoStar. This trend makes some sense, because the work-from-home trend has thinned the crowds of commuters in the biggest US cities, but still turns traditional market wisdom about office values on its head:
Top-tier buildings have experienced steeper declines in occupancy as well, according to the bank’s analysis. While offices are grouped into classes (A, B and C) meant to reflect their potential attractiveness to lessees, those designations haven’t been a useful way to predict occupancy since Covid, GS finds:
New offices are faring better, holding on to more tenants than older offices. This could be because of their amenities and those nice new-building vibes, as some have argued. But it could also be that new offices can get tenants to sign long-term leases; FIS Global, for example, signed a 15-year lease with One Vanderbilt last year.
Whatever the reason, newer buildings’ occupancy has been notably better than older ones, GS writes:
Offices and medical complexes outside of central business districts (CBDs) have also seen more persistent occupancy levels. As mentioned above, regional banks are bigger lenders in those markets too:
So does this mean investors were wrong to worry about regional banks’ commercial real estate exposure, and more specifically their office loans?
The predictable and somewhat frustrating answer is: we’ll have to wait to find out. Banks with the biggest exposures to offices, listed by GS analysts below, have been providing more detail, but only a few have reported first-quarter results:
Wells Fargo, for its part, gave investors a geographical breakdown of its office loans in its Friday earnings presentation. It also increased its allowance for office-loan losses for a fourth consecutive quarter:
Wells Fargo stock had climbed around 4 per cent between its report and Tuesday morning trading, but it isn’t clear that has much to do with the bank’s office exposure. It also kept its net-interest guidance unchanged and experienced only a small decline in non-interest-bearing deposits.
Still, shareholders do seem encouraged by the latest update from M&T Bank, a proper regional bank that is fifth on GS’s list above. M&T stock gained nearly 8 per cent Monday after its earnings report.
Executives told investors that the bank added reserves against potential losses on CRE loans, and took “some partial charge-offs on a couple of office properties [after] new appraisals on things that were troubled.”
But the bank said most of the loans maturing in the next couple of years weren’t levered aggressively. On one hand, that’s a tricky statement to make, because determining the actual values of office buildings is somewhere between challenging and impossible. On the other, determining the proper post-Covid value of office buildings could take a long time, said M&T CFO Darren King.
With our emphasis:
We keep looking at what’s the pace at which the loans are maturing. And I think what you’ll see, certainly for M&T . . . the office story is one that will play itself out over multiple quarters, if not multiple years . . . a lot of the leases are still not maturing because office leases tend to be longer dated than residential.
Goldman’s credit strategists addressed this dynamic in an April 10 note, where they used the global financial crisis as a guide for how long the market shakeout could take:
For M&T Bank, at least, “about $200mn of office [loans are] maturing each quarter for the next two [quarters],” with a smaller volume maturing in 4Q, its CFO told investors Monday. And “something in the neighbourhood of 75 per cent don’t come due until after 2024,” King added.
But there’s still good reason for caution. Goldman’s credit strategists argue that, broadly, the shakeout process could move faster than it has in years past.
First, lots of CRE loans are maturing in the next two years. GS laid out the refinancing schedule in the chart below, though they didn’t specify what share of the borrowers are offices:
Second, the GS strategists argue that “relative to the last two decades, [the office market] has never been as oversupplied as it is today.”
In general, lenders are often willing to ‘amend and extend’ the terms of loans to avoid taking losses if markets aren’t co-operating at maturity time. (This practice is less generously called ‘extend and pretend’ or even ‘delay and pray’).
But the abundance of supply means that the office owners/landlords may just want to default and offload the properties on to their lenders (banks included). And regulator scrutiny of regional banks could leave those particular lenders with less flexibility on their balance sheets to manage their forced ownership of those properties.
Better hope those occupancy rates stay strong!
Source Financial Times https://on.ft.com/41HBIxR