Fears about office-space loans are 'overblown,' Citi says

By Steve Gelsi

Banks have already set aside $39 billion to cover commercial-real-estate losses

While commercial-real-estate loan delinquencies will increase, the $39 billion that banks have already set aside to cover losses should be enough to mitigate any impact to the system, Citi analysts said Friday.

In reaction to regional-bank-stock losses that followed trouble with an office loan and a multifamily loan at New York Community Bancorp INc. (NYCB) earlier this year, Citi analysts said jitters in the sector appear to be overblown.

"Bottom line, while we do expect that commercial real estate delinquency rates will rise and losses will gradually accrue over the next several years, the level of losses that we envision is broadly in line with a normal cyclical downturn," Citi economic analysts said.

That view didn't rule out the impact of a rise in delinquencies.

This in turn could force some banks out of business but will not necessarily pose a systemic risk, Fortress Investment Group co-CEO Joshua Pack told Bloomberg.

"You're going to see more of this consolidation and/or liquidation of U.S. banks," Pack said. "A lot more eggs are going to get broken."

Meanwhile, M&T Bank Corp. (MTB) and Citizens Financial Group Inc. (CFG) were highlighted by Citi analysts to "leverage our view that fears are currently overblown." Citi upgraded Citizens Financial to buy from hold earlier this month.

Meanwhile, regional banks Popular Inc. (BPOP), Comerica Inc. (CMA), First Horizon Corp. (FHN) and KeyCorp (KEY) will benefit from limited office exposure, Citi analysts said.

The Citi report, titled "Global Multi-Asset Strategy, CRE: The Three Trillion Dollar Banking Question," said it expects bank losses to be well below those recorded during the global financial crisis of 2007-09, when bank failures affected several hundred institutions.

Analyst Jeffrey Berenbaum said banks have reserved $39 billion, or 1.4% of total commercial-real-estate loan balances, against potential related losses.

Delinquency rates in the office subsector are currently at 1.5%, while those for multifamily are at 0.4%. At these levels, banks could lose $5.5 billion on loans, assuming a 50% recovery rate.

"Even if delinquency rates rise to the 6% level seen during the [financial crisis], implying losses of up to $35 billion, the reserved amount would still be sufficient," he said.

During the 1990s real-estate crisis, commercial-real-estate charge-off rates peaked at 2%. The office component, which has been impacted as more people work from home, is estimated at 20% of the total commercial-real-estate business.

"Despite recent revelations about commercial real estate exposures at New York Community Bank, markets have remained somewhat sanguine about potential fallout from CRE to the banking system more broadly - and, in our view, the fundamentals look reasonably aligned with the market's assessment," Citi analyst Nathan Sheets said.

The larger money-center and regional banks have generally charged off debt related to commercial real estate or set aside allowances on loans expected to sour, he said.

"While many small and mid-tier banks, which are particularly exposed to CRE, have not been as aggressive in reserving against exposures, their loans tend to have lower risk attributes - e.g., smaller balances, suburban locations," Sheets said.

For its part, Fortress Investment Group has acquired about $1.5 billion of performing office loans from financial institutions at prices ranging from 50 cents to 69 cents on the dollar, Pack said on Bloomberg's "Credit Edge" podcast.

The company is positioning itself for a potential trillion-dollar opportunity in troubled assets. The Federal Deposit Insurance Corp. may need to be more open to nonbank buyers of failed bank assets, Pack said.

"They're just going to have to utilize private capital to help clean up the mess and to help recapitalize the system," he said.

Also read: New York Community Bancorp led increase in loan-loss reserves by big regional banks as lenders brace for potential downturn

-Steve Gelsi

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02-23-24 1157ET

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