Largest U.S. banks can handle their ‘problematic’ office exposure, S&P says

The largest U.S. banks face “problematic” exposure to office real estate, but they’re big enough to handle it, according to a recent analysis from S&P Global Ratings.

That’s the conclusion from S&P after reviewing fourth-quarter updates from nine major U.S. banks: JPMorgan Chase & Co.
Bank of America Corp.
Bank of New York Mellon Corp.
Citigroup Inc.
Goldman Sachs Group Inc.
Morgan Stanley
Wells Fargo & Co.

and State Street Corp.

These banks are known as global systemically important banks, because they are among the largest financial institutions in the U.S. and help run the country’s economic machinery.

S&P also includes Northern Trust Corp.

in its analysis, because that is a peer of custody banks State Street and BNY Mellon.

While 2023 was a tough year because of rising interest rates, fewer merger and acquisition deals and initial public offerings, and the failure of Silicon Valley Bank and several other regional lenders, additional challenges await, S&P said.

One threat is decreased valuations in office real estate as a component of commercial real estate as a result of more people working from home in the wake of the COVID-19 pandemic.

“Office CRE remains problematic, but is only a small portion of GSIB loans,” S&P said in a note published Thursday.

While the big U.S. banks are the largest commercial-real-estate lenders by dollar volume, loan activity in that sector accounts for a “relatively small” percentage of their overall portfolios, S&P said.

“Office properties remain the most vulnerable, given structural changes, but make up a low percentage of loans,” S&P said. “That said, materially higher rates add headwinds to both CRE prices and refinancing ability, no matter the property type.”

Crunching the figures from the most recent quarters, S&P said loss rates on all loans have increased modestly but consistently over the past few quarters.

“Nonperforming and delinquent loans remain low but will continue to inch higher as the credit cycle normalizes,” S&P said. “We expect further deterioration, as higher rates, slowing economic metrics, and inflation will likely hurt loan performance.”

Trading revenue was down 4% and and investment-banking revenue fell 10% in 2023 compared with 2022, due to lower client activity in the face of less favorable market conditions.

Fixed-income revenue moved lower, while commodities and currencies revenue dropped due to reduced client activity and market volatility. This offset some improvement in rates, credit and securitized products.

Equity trading revenue was down, but equity underwriting “was a bright spot in 2023, benefiting from higher secondary and convertible offerings — offset by lower initial public offerings,” S&P said.

After breaking out special-assessment costs levied by the Federal Deposit Insurance Corp. for the bank failures and other items, the GSIBs reported “strong” earnings that rose from the prior year.

For 2024, rising credit provisions and a potential drop in net interest income from elevated interest-rate payments will likely weigh on earnings, S&P said.

Nevertheless, the GSIBs offer “solid profitability prospects despite a potential earnings dip in 2024,” S&P said.

Fee income could rise in some segments, such as mortgage and investment banking, especially if rates fall. Trading revenue is expected to remain relatively healthy, with “strong” profitability, S&P said.

“We think GSIBs will accrete capital through earnings retention, mainly due to caution about the economy and the Basel III Endgame proposal,” S&P said. ”Consequently, the pace of capital distributions will likely be measured.”

S&P was referring to proposed capital requirements as federal banking regulators put the finishing touches on the international Basel banking accords drafted in the wake of the global financial crisis of 2007-09.

Also read: Fed cop Michael Barr defends higher capital requirements as bankers bristle

“We expect delinquencies and charge-offs to gradually rise amid limited economic growth, stress in commercial real estate (CRE), and
declining consumer savings,” S&P said. “We are watching price declines and maturities in CRE and credit cards particularly, and we expect provisions for credit losses to continue to increase. Overall, asset quality pressure will increase but remain manageable.”

Also read: Wall Street’s biggest banks are beating investment-banking revenue estimates

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