Office real estate values are moving down so fast that banking giants like Wells Fargo are already bracing for losses

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As the undeniable permanence of remote and hybrid work takes hold, the profound impact on the office sector is becoming increasingly clear. Vacancies are rising and values are falling, and it’s all happening in an era of higher interest rates and tightened credit. Banks are taking notice of the distress within commercial real estate, and in some cases, with their own office loan portfolios, they’re bracing for losses. 

Morgan Stanley reported its financial results for the second quarter of 2023 this week, which stated: “increases in provisions for credit losses were primarily driven by credit deteriorations in the commercial real estate sector as well as modest growth across the portfolio.” Morgan Stanley’s provision for credit losses rose from $82 million in the second quarter of last year to $97 million, where it currently stands. 

Bank of America also reported its earnings for the quarter, showing an increase in its allowance for credit losses. For commercial real estate, that rose from $1.2 billion in the first quarter of this year to $1.3 billion in the second quarter. Among its commercial real estate loans, 25% are in the office category, totaling to $18.3 billion. In a breakdown of Bank of America’s scheduled office loan maturities, we can see that $6.3 billion worth of loans are coming due in 2024.

Meanwhile, Wells Fargo’s chief executive officer, Charlie Scharf, said the bank experienced “higher losses in commercial real estate, primarily in the office portfolio,” per its earnings report released last week. 

Scharf continued: “We had a $949 million increase in the allowance for credit losses, primarily for commercial real estate office loans, as well as for higher credit card loan balances. While we haven’t seen significant losses in our office portfolio to-date, we are reserving for the weakness that we expect to play out in that market over time.” 

Further down in the earnings report, that $949 million increase in the allowance for credit losses was labeled as primarily for commercial real estate office loans. Still Wells Fargo’s commercial real estate revenue increased to $1.33 billion, up 2% from the previous quarter and 26% from the previous year. Whether that positive trend will continue, we’ll have to wait and see, given the bank attributed the increase to “higher interest rates and higher loan balances.” 

Wells Fargo had $154.3 billion worth of commercial real estate loans outstanding at the end of the second quarter, with $33.1 billion worth of office loans—that’s 3% of its total outstanding loans. How much of that will be maturing in the next year or so, we don’t know. When an analyst asked the bank’s chief financial officer during its earnings call, he responded that they don’t disclose that information, but that we should assume the bank’s loans are three to five years as that’s the standard, according to a transcript of the call

Regarding JPMorgan, which announced its second-quarter earnings last week, the company reported a provision for credit losses amounting to $1.1 billion. This provision included a reserve of $608 million specifically established for the First Republic portfolio, which JPMorgan acquired in May subsequent to the collapses of Silicon Valley Bank and Signature Bank.

“Excluding First Republic, the provision [for credit losses] was $489 million, reflecting a net reserve build of $389 million, driven by updates to certain assumptions related to office real estate, as well as net downgrade activity in Middle Market. Net charge-offs of $100 million were predominantly driven by office real estate,” according to the release

However, JPMorgan’s commercial real estate revenue increased to $806 million in the second quarter, from $642 million the previous quarter. In JPMorgan’s earnings call, its chief financial officer told investors and analysts that the bank’s office portfolio is “quite small and our exposure to sort of so-called urban dense office is even smaller. The vast majority of our overall portfolio is multifamily lending,” according to a transcript of the call.

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