Wells Fargo is offering some cautions about the health of office loans, a potentially worrying sign for smaller banks with larger exposures to a segment that's been hit by changing work habits.
The office sector "continues to show signs of weakness" amid higher interest rates and companies' rethinking of their physical footprints after the pandemic, Wells Fargo Chief Financial Officer Michael Santomassimo told analysts Friday.
The warning came as investors
During the first quarter, Wells Fargo took more aggressive steps to guard against the risk that some of its commercial real estate loans won't be repaid. The bank's allowance for loan losses for CRE loans jumped 22% from last quarter.
The San Francisco bank hasn't seen the current weakness translate into meaningful losses, but Santomassimo said "we expect to see more stress over time." The $1.9 trillion-asset bank is taking a more cautious approach in making new loans and will continue to "proactively work with borrowers" to manage its exposures, he added.
"We will continue to closely monitor this portfolio, but as has been the case in prior cycles, this will likely play out over an extended period of time," Santomassimo said on the bank's first-quarter earnings call.
Office loans make up about 4% of Wells Fargo's total loan book, which is a "manageable" level, according to Kyle Sanders, senior equity research analyst at Edward Jones.
But community and midsize banks have far larger exposures, he added, and Wells Fargo's cautions don't bode well for those lenders, which will start reporting earnings next week.
"For Wells to come out and say, 'There's some real issues here,' I think that could be problematic for some of the smaller banks that are already under pressure," Sanders said. He pointed to stock price drops at regional banks after the March 10 failure of Silicon Valley Bank.
Wells Fargo prepared a slide for investors with details on its office loans, which make up 23% of its commercial real estate portfolio, the second largest category after apartment buildings. Roughly 42% of those office loans are in California and New York, but the portfolio is "geographically diverse" and spread out across the country, Santomassimo said.
Weaknesses are more evident in larger cities, Santomassimo said, flagging San Francisco, Los Angeles and Seattle as three places where office space could face heightened stress.
Most of Wells Fargo's office loans are within its corporate and investment banking division, where the vast majority of the portfolio is "institutional-quality real estate with high-caliber sponsors," Santomassimo said.
The bank is taking a "very granular, property by property" approach in managing its exposures and monitoring borrowers' health, he added.
"What we're doing is really just making sure we stress it in a whole bunch of different ways, on a property-level basis, to make sure we understand where the potential issues might come from," Santomassimo said.
PNC Financial Services is taking a similar approach, CFO Robert Reilly told analysts Friday after the $561 billion-asset bank reported its earnings. Office loans comprise 2.7% of PNC's total loan portfolio, according to slides that the Pittsburgh-based bank created for investors.
The bank's office loans are "well-diversified across geography, tenant type and property classification," Reilly said, adding that PNC has built up its loan loss reserves over several quarters to guard against risks.
Even so, PNC is stress testing each of its office loans, continuously updating key metrics such as tenant retention and relying less on third-party appraisals that can be slower to adjust to market conditions.
"We have a highly experienced team that is reviewing each asset in the portfolio to set appropriate action plans and test reserve adequacy," Reilly said.
Shares in PNC were down 1.2% in mid-afternoon trading, and shares in Wells Fargo were down 0.43%. Both banks' stock prices were underperforming that of JPMorgan Chase, where CFO Jeremy Barnum said Friday the bank's exposure to the office sector is "quite small."
JPMorgan, which reported a large increase in deposits during the first quarter and made an upward revision Friday to its outlook for net interest income, saw its stock shoot up more than 7%.
