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Regional banks face rising non-performing loans

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Rate cuts can ease strain on other CRE segments

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Analysts foresee continued challenges for office loans

By Niket Nishant and Manya Saini

Oct 29 (Reuters) - U.S. regional banks continue to

grapple with pressures in their office loan books as remote work

stays prevalent, but rate cuts may provide some relief by easing

the strain on other commercial real estate (CRE) segments,

analysts said.

Nearly a dozen mid-sized and regional U.S. banks reported

higher non-performing loans (NPLs) - debt where borrowers missed

scheduled payments - in their CRE portfolios in the third

quarter compared with a year earlier, a Reuters analysis of

earnings reports showed.

Those included KeyCorp ( KEY ) and Fifth Third Bancorp ( FITB )

.

A looming "maturity wall" could complicate matters further.

When loans mature, borrowers must either refinance or repay the

remaining balance in full. Failure to do so could lead to

defaults and strain banks' balance sheets.

Roughly $950 billion of CRE mortgages are expected to mature

in 2024, of which 10% are tied to office properties, according

to estimates from S&P Global Market Intelligence.

Office loans present unique challenges due to the rise of

hybrid work, which may limit their benefits from lower interest

rates.

Rate cuts "may not fully alleviate office pressures in the

short term, as the shift toward remote and hybrid work and the

increasing use of AI to supplement call centers and other

services has fundamentally weakened demand", said Michael Ashley

Schulman, chief investment officer at Running Point Capital.

Banks may extend loan terms to delay recognizing the

impairment, but such "extend-and-pretend" strategies pose risks

to the broader financial system, according to a paper released

last week by the Federal Reserve Bank of New York.

Flagstar Financial ( FLG/PA ), formerly named New York

Community Bancorp, said it took "substantial charge-offs" of

$388 million on its $2.6 billion office portfolio.

The troubled regional lender's large CRE exposure in-part

was the trigger behind a sector-wide crisis earlier this year.

KeyCorp ( KEY ) reported NPLs of 5.1% in its small office portfolio,

versus 2.3% a year earlier.

Fifth Third's office NPLs stood at 0.18% of its total

portfolio, up from 0.16% a year ago. The bank is not pursuing

new office CRE loan originations.

RELIEF ON THE HORIZON

Portfolios other than office could see some easing as a

long-awaited cycle of rate cuts begins, ratings agency Fitch

said, noting potential benefits to multifamily loans.

"The Federal Reserve's pivot to interest-rate reductions

last month, and the eventual end of its quantitative tightening

program ... should create a more supportive backdrop," said

Jason Benowitz, senior portfolio manager at investment firm

Segall Bryant & Hamill.

Still, it may take banks years to put CRE troubles behind.

"I anticipate continued challenges in CRE in the years

ahead. Office demand has been reduced by remote work adoption.

Retail space faces a similar headwind from e-commerce adoption.

Warehouses were over-absorbed in the pandemic period and have

begun a period of normalization," Benowitz said.

According to Running Point's Schulman, lenders must maintain

adequate capital beyond 2025 to deal with such weaknesses.

M&T Bank ( MTB ) reported total criticized office loans -

those flagged for potential repayment issues - of roughly $1.31

billion, versus $1.22 billion in the second quarter.

U.S. Bancorp ( USB ) said the office portfolio continues to

see stress even though the macroeconomic environment has

stabilized.

Mirroring trends at peers, its CRE charge-offs and NPLs

climbed in the quarter, with the lender attributing it primarily

to the office segment.

Earlier this month, Wells Fargo ( WFC ) CEO Charlie Scharf

said the U.S. banking giant may lose $2 billion to $3 billion on

its CRE loan portfolio over the next three to four years, though

it has been provisioned.

Flagstar and Fifth Third declined to comment. Others did not

immediately respond.