As big banks reported their earnings for the second quarter of 2024, the commercial real estate (CRE) sector watched closely for signs of overall deterioration of credit quality and looming defaults of underperforming loans. The upshot is the big six (in terms of assets)— JPMorgan Chase & Co., Bank of America, Citigroup, Wells Fargo & Co., Goldman Sachs Group, Inc., and Morgan Stanley—beat analyst estimates while CRE office exposure continued to be a concern.
Diving into the Bank Earnings Reports: The Rising Tide
Wall Street deal making is making a comeback. The big six reported double-digit jumps in investment banking revenue driven by growth in mergers and acquisitions and equity underwriting.
“The fact that banks are seeing IPOs, increased trading revenues, and active transactions is a positive movement for the broader market,” said Manus Clancy, head of Data Strategy in the CRE Weekly Podcast on the topic of quarterly bank performance.
Clancy noted that it’s still early, but it’s a good sign that transaction activity is picking up as investors gain confidence that the economy is on stable footing. Since 2022, banks had seen dealmaking activity drop significantly coincident with the Federal Reserve raising the benchmark interest rate.
CRE Loan Portfolios: “Not out of the Woods Yet”
While some of the banks saw increases in office loan losses, results seemed in line with expectations.
Wells Fargo reported higher losses in the second quarter tied to office properties. The bank reported an increase in commercial net loan charge-offs, which were up $127 million from the first quarter to 35 basis points of average loans. Wells’ CEO Charlie Scharf shared during the company’s earnings call that CRE office losses have been and will continue to be ‘lumpy’ as they work to derisk office exposure. These efforts helped to reduce Wells’ office commitment by 13% and loan balances by 9% from a year ago. From their earnings call: “Fundamentals in the institutional owned office real estate market continued to deteriorate as lower appraisals reflect the weak leasing market in many large metropolitan areas across the country.”
Goldman Sachs highlighted gains in real estate investments in its equity investment line for the quarter, but there was an important footnote. Year-over-year growth was attributed to both the closing of a $10 billion fund last quarter and fewer markdowns from the prior year. Last year the bank marked down or impaired its office-related CRE exposure across equity and consolidated investment entities by 50%, according to S&P Global.
CFO Denis Coleman told analysts: “We were sort of an early mover in addressing some of the commercial real estate risk across our balance sheet.”
Bank of America reported that it continues to “aggressively work through its modest CRE office portfolio.” The bank reported decreases across several metrics: reservable criticized loans, non-performing loans, and net charge-offs, suggesting stabilization. Meanwhile, Morgan Stanley reported net charge-offs of $48 million, primarily related to CRE loans.
JPMorgan reported an increase in net charge offs in commercial and investment banking business comprised of office property mortgages. The provision for credit losses was $384 million, reflecting a net reserve build of $220 million and net charge-offs of $164 million, of which approximately half was in office.
“The CRE market, particularly the office sector, faces significant challenges and potential bumps ahead.” Clancy said. “We’re not out of the woods yet, and an increase in nonperforming loans could be on the horizon. It’s a reminder that this market cycle is far from over, and vigilance is key,” Clancy said.
CRE Non-Performing Loans Increase but Remain Far from Previous Peaks
Turning to non-performing loan (NPL) ratios, which assess the quality of the bank’s loan portfolio and its exposure to credit risk, the metric was mixed across the big banks. Non-performing loans have stopped generating income for the lender as the borrower has usually not made a payment for 90 days or more.
While the quarterly NPL ratios for banks like Wells increased from 2.6% to 3% quarter over quarter, overall, the ratios are far from their peaks, Clancy noted during the CRE Weekly Podcast. “NPL ratios remain an area to watch in coming quarters,” Clancy said.
| Non-Performing Loan Ratios | |||
| Q2 2024 | Q1 2024 | Peak after 2008 | |
| Wells | 3% | 2.6% | 6.6% |
| B of A | 2.8% | 3.2% | 10.8% |
| JPMorgan | 0.6% | 0.5% | 4.8% |
| Citigroup | 0.4% | 0.7% | 15.3% |
Bifurcated Consumer Health Worth Watching
Citigroup reported that while the overall U.S. consumer remains resilient, there is a notable divergence in performance and behavior across income levels. Specifically, only the highest income quartile has more savings now than they did at the beginning of 2019.
For CRE sectors that rely on consumer spending— namely retail and hospitality—the lower savings levels outside of top income bracket could have knock-on effects as consumers continue to be selective in their spending. The effects are shown in recent data: retail sales were flat in June compared to May and banks reported increasing credit card balances.
“The one-two punch of elevated inflation and higher borrowing costs have put more pressure on consumers, and banks are preparing by increasing their credit loss provisions for consumer loans,” said Candi Coleman, Head of Lender Strategy.
In the recent earnings calls, Citigroup reported that its credit card delinquencies have increased since last year. And JP Morgan increased reserves for credit card losses.
Looking Ahead
Overall, bank Q2 2024 earnings results held some upside surprises and the expected areas of concern in CRE office. “Quarterly results revealed an industry that is bruised but not battered,” Clancy said.
Regarding the outlook, several of the earnings calls highlighted areas of future risk: geopolitical uncertainty, inflation, and regulatory changes. Market consensus is that interest rates are at their peak. Near-term, analysts point out that banks’ net interest income (NII) could get squeezed, as the Federal Reserve reduces interest rates, which is expected to start September of this year. Lower rates would put downward pressure on the banks’ earnings from interest-bearing assets until loan transaction activity surges meaningfully. And that may take time.
