These banks have lots of office loans. Here's why they say it's OK.

June 27, 2023 9:00 PM

Loans backed by office buildings are currently drawing major scrutiny, as the rise of remote work has led to higher vacancy rates and sparked fears that some lenders will face big losses in the coming years.

Much of the focus has been on smaller regional banks, which tend to have greater exposure to the commercial real estate sector than their larger counterparts.

At banks with between $10 billion and $100 billion of assets, commercial real estate loans accounted for 33.2% of total loans at the end of the first quarter, compared with 12.8% at bigger banks, according to a recent analysis by S&P Global Ratings.

So far, losses on office loans remain low. The repricing of office properties is expected to play out over several years, and many property owners are still paying relatively low interest rates that they secured before the Federal Reserve started hiking rates last year.

As the rates that borrowers pay rise, S&P expects more charge-offs.

"If you were paying a low-rate fixed loan, and it moves to a much higher rate variable-rate loan, it's going to be more challenging to make payments," said Stuart Plesser, an analyst at S&P.

But Plesser also said that commercial real estate loans have better underwriting than they did in 2008 — the last time that the sector faced the prospect of a large downturn. Today, loan-to-value ratios, which measure the cushion that lenders have against falling property values, are typically in the 50%-65% range, according to S&P.

"Prices would have to come down significantly to bleed into charge-offs," Plesser said. "Not saying it won't happen, but there's more cushion."

S&P identified banks with more than $10 billion of assets, but less than $100 billion, that have notable exposures to office loans. The list includes Cullen/Frost Bankers, Columbia Banking System, Synovus Financial, Valley National Bancorp and Associated Banc-Corp.

Executives at all of those banks have spoken publicly in recent months about their institutions' exposure to office loans. They have pointed to factors that offer protection, including the geographic advantages of their portfolios and the types of buildings that serve as collateral.

Analysts at JPMorgan Chase recently expressed a similar viewpoint, saying that they think concerns about regional banks' exposure to commercial real estate are "overblown."

What follows is a look at the situation facing five regional banks that have significant exposure to office loans.

Cullen Frost Bankers

Office loans as a percentage of total loans: 12.7%

At the parent company of Frost Bank, about half of all office loans are on owner-occupied properties, CEO Phil Green said during an April 27 call with analysts.

"We consider owner-occupied properties to have a lower risk profile," Green said, explaining that San Antonio-based Cullen/Frost relies on the owner-occupants' operating cash flow, rather than the income generated by the underlying real estate, as the source of repayment.

Green also said that the bank's office loans are predominantly on so-called Class A properties — which are typically newer buildings that have generally had higher occupancy rates than older properties.

The $51 billion-asset bank's office loan portfolio had roughly $2.2 billion of outstanding loans, according to Green. Office loans accounted for around 35% of its Tier 1 capital, according to S&P.

"Higher interest rates have certainly led to some decline in coverage ratios and will probably lead to some valuation declines, but we're starting from a strong position with good cushion," Green said.

Columbia Banking System

Office loans as a percentage of total loans: 8%

At the $54 billion-asset parent company of Umpqua Bank, a majority of office loans are in suburban areas, according to bank executives. Real estate prices in the suburbs and smaller cities are generally expected to be less volatile than in urban areas.

"We have very limited exposure to core downtown metro markets," Frank Namdar, Columbia's chief credit officer, said during an April call with analysts.

At least 36% of the firm's office loans are in California. Another 28% are in Oregon, and 27% are in Washington state, according to the bank's disclosures. Office loans totaled more than 70% of Tier 1 capital at the end of the first quarter, according to S&P.

Only 0.03% of Columbia's office loans were 30-89 days past due or in nonaccrual status at the end of the first quarter, according to the bank. Another 1.52% were categorized as "special mention," meaning that they had potential weaknesses that merited the close attention of the bank's management.

Synovus Financial

Office loans as a percentage of total loans: 7%

Columbus, Georgia-based Synovus says that its exposure to the sector is weighted toward loans on medical office buildings, which have been shielded from the rise of remote work. Medical office loans account for just over half of the bank's $3.1 billion office-loan portfolio.

"So it's a different asset class than your traditional office space, because people are still going into medical offices," Synovus CEO Kevin Blair told investors back in February.

The $61.8 billion-asset bank does not have a lot of exposure to buildings constructed before 2010, or to those that are located in slow-growth markets, Blair said. The top markets for the bank's nonmedical office loans were Atlanta; Charlotte, North Carolina; Charleston, South Carolina; Miami; and Tampa, Florida.

"So being in this footprint is going to be an insulating factor for whatever happens in the national environment," Blair said.

Office loans totaled nearly 70% of the company's Tier 1 capital at the end of the first quarter, according to S&P.

Valley National Bancorp

Office loans as a percentage of total loans: 5.5%

At the end of the first quarter, the parent company of Valley Bank pointed to the strong credit performance of its office loans. The $64.3 billion-asset bank said that it had a single $315,000 office loan in nonaccrual status, and that the portfolio has had no recent charge-offs.

"The credit metrics on this portfolio are extremely strong, and we have not experienced any losses in our recent history," Thomas Iadanza, Valley's president, said during the bank's most recent quarterly earnings call.

"We understand the concerns over office collateral in general, but believe our portfolio is positioned to perform well."

Some 36% of the Wayne, New Jersey-based bank's exposure to office loans is in Florida and Alabama, according to its disclosures at the end of the first quarter. Another 26% is in New Jersey. And 21% of the exposure is in New York, including 6% in Manhattan.

As of March 31, office loans accounted for nearly 70% of Valley's Tier 1 capital, according to S&P.

Associated Banc-Corp

Office loans as a percentage of total loans: 3.6%

Green Bay, Wisconsin-based Associated has emphasized that its exposure to office loans is weighted toward higher-end properties in the suburbs.

Some 78% of its office loans were suburban, and 52% were on Class A properties, Associated Bank's parent company said in a May 11 presentation.

While the $40.7 billion-asset bank did not provide a geographic breakdown of its office loans, it said that about 70% of its commercial real estate loans are in Midwestern states, led by Wisconsin and Illinois.

Office loans account for roughly half of Tier 1 capital at Associated, according to S&P.

"While we continue to monitor this portfolio closely, we feel well positioned given our business-model approach and the markets that we operate in," CEO Andy Harmening said during an April 20 call with analysts.