Following the failures of Silicon Valley Bank and Signature Bank — and Silvergate Bank's demise through liquidation — analysts and investors are looking for the next potential shoe to drop.
Silicon Valley Bank's outsize deposit
Experts say the troubles amplified the risk-taking inherent in banking. With economists forecasting a recession this year amid stubborn inflation and lofty interest rates, analysts are also sharpening their collective focus on threats embedded in commercial real estate, given many small and midsize banks' dependence on such lending, and they are homing in on the
"A lot of banks are going to have to step up disclosures about their office exposure," said Chris Marinac, the director of research at Janney Montgomery Scott. "What are they really doing to stress test office loans, and what are they actually doing about problems?"
As lease agreements expire, more companies are expected to scale back on office space in light of the enduring remote-work trends and the high cost of living in major cities. Layoffs across the technology industry are compounding problems. This could leave landlords grappling with rising vacancies and falling revenue; many could struggle to service their debts.
The U.S. vacancy rate across the office sector increased from about 12% at the start of 2022 to 17% early this year, according to data provider IBISWorld. That matched the rate from the 2008 financial crisis and was up from less than 10% at the start of 2020, prior to the pandemic.
D.A. Davidson analysts noted in a report that when including subleasing, total vacancy rates may actually exceed 20%. "At 15%-20% vacancy, debt service concerns emerge and understandably the segment has entered the credit concern spotlight," they wrote.
The U.S. office market accounts for about $3 trillion of the $20 trillion commercial real estate market, according to Jones Lang LaSalle.
The Davidson analysts said that historically, office properties have rebounded from downturns. But the current slump "likely gets worse before it gets better," they said, citing studies from Kastle Systems, which makes swipe-in systems to track office attendance. It found that the busiest days of in-office work are midweek, yet average office attendance is only 58%. On Fridays, the slowest day, only 35% of the workforce reports to the office.
"Higher rates and a
For their part, banks with substantial office exposure have pulled back from the sector. Of the 17 banks with at least $400 million of office loans, nine trimmed their exposure during the fourth quarter, according to S&P Global data.
During recent earnings calls, bank executives said they were increasingly cautious, particularly in downtown areas of major cities that are reliant on the flow of workers in and out of office towers.
"I think the office space could get soft. I think it has gotten soft in places," FB Financial Corp. President and CEO Christopher Holmes told analysts during an earnings call. The $12.8 billion-asset FB in Nashville said about 23% of its commercial real estate loans are office related, though it is avoiding high-rise buildings in the central business districts of Nashville and other major markets, preferring smaller workplaces in suburban areas.
Eagle Bancorp in Bethesda, Maryland, said it also favors suburban properties. The $11.2 billion-asset bank operates in and around Washington, D.C. "Post-pandemic, economic activity in the suburban areas continues to outperform … downtown D.C.," Executive Vice President Janice Williams said on an earnings call. "Large parts of the federal government continue to work remotely. Private businesses are more of a mixed bag."
Analysts at Keefe, Bruyette & Woods forecast that from mid-2022 to late this year, office property values will collectively drop by 30% or more. At-risk markets include San Francisco, New York City, Seattle, Austin, Phoenix, Washington, D.C. "and others that are tech- or remote-heavy" and "facing elevated supply."
The KBW analysts said problems in the office space are likely to spread to apartments and retail properties that are located close to office complexes and depend on workers living and shopping near their workplaces.
Trepp analyst Manus Clancy said the problems in office properties are bound to worsen substantially this year, with knock-on effects to develop in tandem.
"Office values have fallen and will continue to fall," he said. "The delinquency rate for offices can only go up."
