FDIC – Risk Review: Commercial Real Estate

Blog article

Risk Review (the “Review”) for 2024 has been published by the FDIC.  The Review summarizes the FDIC’s assessment of risks in economic and market conditions affecting the banking industry.  Below, the section on Commercial Real Estate as part of Credit Risk in the Review is summarized.  The full report is available here, 2024 Risk Review.

Markets for most major CRE property types were resilient in 2023, but the office sector struggled.

• Net absorption of office space was negative for the fourth straight year in 2023, which means that more office space was vacated than was newly leased.
• Demand for space was particularly weak in the largest U.S. office markets, reflecting in part the continuation of remote work and slow return to office in many cities.
• The retail property sector performed well in 2023. There is a weak link in retail sector, though, which is mall space. Mall space has struggled with elevated supply of obsolete malls since before the pandemic.
• Office building prices were soft amid weak demand for space. It is projected in the Review that some sectors, like office, will likely take time to recover.

The Review indicated that CRE loan exposure remained elevated among the nation’s banks as the loans held by banks grew for the 43rd consecutive quarter, reaching a record of more than $3.1 trillion in fourth quarter 2023.  The growth rate slowed, though, owing to tighter underwriting standards, higher interest rates, and lower loan demand.

In terms of CRE credit quality, the Review indicates that it remained generally favorable, but rising delinquencies create uncertainty. In response, some banks increased provisions for potential deterioration in CRE loans. According to the Review, the increasing trend in CRE loan delinquencies was distinctly more pronounced among the largest banks, i.e., banks with assets greater than $100 billion, which experienced a sharp rise in nonfarm nonresidential loan delinquencies, the category that includes office loans.

The Review indicates that refinancing of CRE loans could be challenging for some borrowers. The difficulties the borrowers face in terms of refinancing are:

• The rising trend in delinquencies, coupled with softening collateral values, could weaken CRE loan portfolios, particularly from loans coming due during this period of higher interest rates.
• Higher borrowing costs, which affect repayment capacity, and lower collateral values, two essential components considered by lenders.

An estimated $1.6 trillion in CRE loans mature between 2024 and 2026. More than half of these maturing CRE loans are held by banks and are predominantly loans to finance nonfarm nonresidential properties, which include office loans.

The Review concluded that though CRE credit quality was resilient in 2023, weak office space demand and rising borrowing costs in the higher rate environment are likely to weigh on CRE performance in 2024.