July 19 (Reuters) - U.S. banks have boosted their

provisions for credit losses as deteriorating commercial real

estate (CRE) loans and high interest rates fuel fears of

defaults, the regional lenders' second-quarter results show.

Some, such as M&T Bank ( MTB ), are also gradually reducing

their exposure to the troubled CRE sector and repositioning

their balance sheets to focus on commercial and industrial

lending and build capital.

Office loans have been hit the hardest over the past 12

months as buildings remain vacant due to the post-pandemic

adoption of remote working models.

The shift has hurt landlords who have been unable to pay

back mortgages, while options to refinance the properties have

been constrained by higher rates.

BankUnited ( BKU ), which according to data from S&P Market

Intelligence, had one of the largest CRE exposures by loan

volume, revealed office loans accounted for 30% of its total CRE

loan book.

Office portfolio allowance for credit losses climbed to

2.47% at the bank as of June 30, compared to 2.26% at the end of

the first quarter, and just 1.18% at the close of 2023.

Meanwhile, multi-family commercial loan portfolios - most of

which are made by smaller U.S. lenders - have also shown signs

of strain in major markets such as New York and Florida due to

rent control regulations.

"As is common industry practice after a time of extended

elevated interest rates, some cracks are beginning to show,"

said Jeff Holzmann, COO at RREAF Holdings, a real estate

investment firm with over $5 billion in assets under management.

"The reason for the delayed response is the fact that

lenders demand interest reserves that can run out after some

time. But as time goes by, reserves are depleted and options run

out resulting in lenders having to write down, or write off some

loans or positions,"

At KeyCorp ( KEY ), net-charge offs to average loans for CRE

rose to 0.21% in the second quarter, from 0.14% in the previous

quarter. Non-performing office loans at the bank increased to

5.5% from 5.2% over the same period.

Bank OZK ( OZK ) raised its total allowance for credit

losses to $574.1 million in the second quarter, compared with

$426.8 million in the year-ago period. Net charge-offs, or debt

unlikely to be recovered, rose to $11.8 million from $8.7

million over the same period.

"It's imperative that banks have rigorously scrutinized

their CRE portfolios, clearly communicated the specific areas of

exposure and their multi-scenario strategies for mitigating

these risk," said Blake Coules, CRE industry practice lead,

Moody's.

"Detailed analyses should go beyond broad asset classes or

geographic locations - such generalities may suggest a bank

hasn't fully risen to the challenge," he added.

NO PANIC SELLING

Earnings reports so far this week show lenders are not

aggressively selling down their CRE loans and are allowing them

to run off the balance sheet naturally instead.

Some had expected regional banks to dump their toxic assets

in distress sales, triggered by the panic sparked by New York

Community Bancorp's ( NYCB/PA ) troubles earlier this year.

"I think loan sales are possible. But flooding the market

with supply is not necessarily what's going to happen," said KBW

analyst Chris McGratty.

Banks might also wait for the Federal Reserve to cut

interest rates, widely expected later this year, before putting

their loan books up for sale. The cuts could help them fetch

higher prices for those assets.

Fed Chair Jerome Powell said earlier this month that CRE

risks will be with banks for years, and regulators were in touch

with smaller banks to ensure they are able to manage them.

"The sky is not falling when it comes to CRE loans,"

Washington Federal CEO Brent Beardall said in a

statement last month, when the bank sold $2.8 billion

multi-family loans without incurring a loss.

Regions Financial ( RF ) also said it expects stress in

multi-family portfolios to be temporary in nature. Fifth Third

said it was not pursuing new office CRE originations.

Meanwhile, NYCB and smaller rival First Foundation ( FFWM )

will likely see heightened investor scrutiny of their loan books

when they report second-quarter results next week, after turmoil

tied to CRE exposures this year.

"I think that will be very telling, especially for some of

the banks that have exposure to rent stabilized multi-family and

the performance issues we've seen there," said Stephen Buschbom,

research director at data provider Trepp.