Office Loans Are The Fed’s ‘Top Concern’ As CRE Delinquencies Reach 10-Year High
Commercial loan delinquencies are at their highest level in a decade and banks are adding to their credit reserves to protect against further losses, according to a new report from the Federal Reserve.
Office sector loan delinquencies, which increased to 11% in the second quarter, remain the Fed’s “top concern,” the agency said in its twice-yearly supervision and regulation report released Friday. The U.S. central bank also noted the multifamily sector had “come under some stress,” with a material and steady uptick in delinquency rates.
Loan deterioration has been mostly concentrated at large banks, but smaller banks have also seen delinquency rates tick up in the first half of 2024, the Fed said.
Still, the Fed said in its report that the banking system “remains sound and resilient overall,” with most banks reporting strong capital levels and liquidity and funding conditions roughly in line with a year earlier.
“However, credit performance in commercial real estate [CRE] lending and some consumer lending sectors continues to show signs of weakness,” according to the Fed report. “Banks are adding to credit loss reserves to protect against potential credit losses.”
The financial sector is already preparing for turmoil in the office debt market, with Fitch Ratings echoing the Fed in June when it raised its office CMBS loan delinquency forecast and reiterated that the sector’s outlook was “deteriorating.”
High interest rates, slower economic growth, a tightened lending environment and a general decline in office demand were all headwinds weighing on office debt, according to Fitch.
Multifamily debt in the CMBS market has also seen a flurry of delinquencies this year. Roughly 7.4% of apartment CMBS loans were either delinquent or in special servicing in July, according to debt tracking firm CRED iQ, up from roughly 3% at the start of the year.
The multifamily stress is partly a product of a slowdown in revenue growth, rising operating costs and shrinking valuations, according to the Fed report.
The Fed has also disclosed the results from its latest round of stress tests of financial institutions with more than $100B in assets, which ranks the banks on performance and preparedness in capital planning, liquidity risk management and governance.
Around a third of large banks passed all three categories in the first half of 2024, with the rest failing to meet expectations in at least one category.
“Most large financial institutions met supervisory expectations with respect to capital planning and liquidity risk management,” the Fed wrote in the report. “However, supervisors identified continued weaknesses in risk-management practices for interest rate risk and liquidity risk.”
Across all securities available for sale, banks reported $203B in fair value losses through the first half of the year, down from $248B the year prior. Banks also reported $308B in fair value losses on held-to-maturity securities, roughly in line with $310B a year earlier.
“2024 stress test results showed that while large banks would endure greater losses than last year’s test, they are well positioned to weather the severe recession they were tested against and stay above minimum capital requirements,” the report states.
Moving forward, the Fed said its supervisory focus would remain on credit risk management practices at large firms, particularly with respect to credit cards and commercial real estate lending.
