Brokers, investors and landlords may be concerned about lagging office demand, but a U.S.-based bank that's one of the largest lenders for those buildings reports seeing some signs of relief on the horizon.
Wells Fargo, the fourth-largest bank in the country, said on Tuesday that credit quality in its portfolio of office-building loans improved further in the second quarter. Loans where the borrower has missed payments fell 3.2% to $7.96 billion from the first quarter as banks reduce holdings of loans that don't generate interest, including those for commercial real estate, especially for office properties.
JPMorgan Chase and Citigroup joined Wells Fargo in reporting earnings Tuesday, the first round of major banks to post second-quarter results. Wells Fargo and JPMorgan have significant portfolios of commercial real estate loans, though they represent less than 15% of their overall loan books, while Citigroup's commercial property lending makes up about 6% of all loans.
The earnings come as banks rid their balance sheets of delinquent office loans, and partly as a result, "credit quality has started to normalize for the industry," Gerard Cassidy, co-head of global financials research at RBC Capital Markets, said in a July 2 research report.
Even so, Cassidy expects that banks need another 12 to 18 months to purge their books of nonperforming office loans down to manageable levels. A Wells Fargo executive echoed Cassidy's forecast.
"As we have said, it will take time for office fundamentals to recover," Mike Santomassimo, Wells Fargo's chief financial officer, said during a Tuesday morning conference call.
Little growth
The results come after about half of commercial real estate professionals recently surveyed by CoStar's market analytics team said conditions in the office sector are still below average, and they don't expect much improvement in the coming months. At the same time, the sales market for office properties has shown some signs of improvement, with one office tower in Portland, Oregon, selling shortly after hitting the market.
JPMorgan Chase, the largest bank in the U.S. by assets, said revenue from commercial real estate banking declined 1% to $862 million from the previous quarter. Its portfolio of commercial real estate loans increased 1% to $146.2 billion. JPMorgan Chase did not break out its commercial real estate loans by specific property types, such as office, hospitality or retail.
BlackRock, the world's largest asset manager, also reported second-quarter earnings on Tuesday. While not a bank, BlackRock invests in commercial real estate in North America, including office properties. The New York-based company said second-quarter revenue climbed 13% to $5.4 billion from the year-earlier period.
BlackRock also said it accepted $46 billion for its investment funds during the quarter, boosting its total assets to a record $12.5 trillion. However, an unidentified institutional client withdrew $52 billion from a BlackRock-managed index fund. It's one of the largest-known redemptions in BlackRock's history, according to business news publication Quartz.
Wells Fargo may be reducing its exposure to office loans in danger of default, but it's not replacing those credits with new office or construction loans. The San Francisco-based company's commercial real estate loan book shrank 1.1% to $44.5 billion in the second quarter, compared to the same period a year earlier. Wells Fargo did, however, make more loans to businesses for things like purchasing inventory and upgrading equipment.
That's the same tactic many lenders have adopted, said Laura Dietzel, partner and real estate assurance leader at consulting firm RSM US.
Some deal reluctance
Still, some investors and banks are walking away from deals, Dietzel told CoStar News.
"Projects are no longer penciling out," she said. "Banks that are willing to lend are only willing to do it with tighter standards."
DivcoWest, lead developer of the Cambridge Crossing mixed-use project in Boston, postponed construction of new multifamily properties at the site because of difficulties in obtaining financing, an executive said last month.
In order to obtain loans from banks, insurance companies or other lenders, "borrowers need to come to the table with more equity," Dietzel said. The additional equity helps protect lenders against potential future defaults.
The reluctance to make commercial real estate loans is because of the impact of tariffs on the economy and inflation and the timing of future Federal Reserve rate cuts, Dietzel said.
"Commercial real estate entered the year with optimism due to the [expectation] of rate cuts," she said. "But that quickly soured due to tariffs."
Bank of America, PNC, Goldman Sachs and M&T Bank are scheduled to report second-quarter results on Wednesday.
CoStar News' reporter Mark Heschmeyer contributed to this article.