Performance of real estate loans tied to office properties for two of the largest U.S. banks — JPMorgan Chase and Wells Fargo — worsened in recent months and bank executives expect the trend to continue for the rest of 2023.
Wells Fargo, the largest U.S. bank lender for commercial properties, increased its loan-loss allowance in the second quarter by $949 million from the first quarter, mainly because of projected weakness in office-based loans and consumer credit cards. The San Francisco-based bank also increased the amount it writes off in loan losses from commercial mortgages by $62 million, mostly because of its lending related to offices.
“While we haven’t seen significant losses in our office portfolio to-date, we are reserving for the weakness that we expect to play out in that market over time,” Wells Fargo CEO Charlie Scharf said in announcing the bank's second-quarter earnings Friday.
Commercial real estate lending has dropped sharply as interest rates rise and uncertainty increases about property valuations. Quarterly growth in commercial mortgages declined to 0.4% in the first three months of 2023, its lowest level in at least five years, according to data from CoStar and the Federal Deposit Insurance Corp.
Office properties are a primary weak point and Wells Fargo’s move to boost reserves signals that most banks should expect to see worsening office conditions, said Allen Tischler, an analyst at Moody’s Investors Service.
“Net charge-offs rose modestly and reserves increased significantly, particularly as the outlook for office ... has deteriorated,” Tischler said in a report.
Wells Fargo and JPMorgan led off this quarter’s bank earnings report season on Friday. Bank of America, PNC Financial Services Group, Morgan Stanley and Western Alliance Bancorp report second-quarter earnings on Monday.
Future Performance
Wells Fargo's Scharf stressed to investors during a Friday conference call that it’s difficult to assess future loan performance based on current factors. He also said the process of resolving office loans will persist for several quarters.
“Loss content will be driven by a combination of factors, including but not limited to property type, location, lease rates, lease renewal notice rates, loan structure and borrower behavior,” Scharf said.
New York-based JPMorgan, meanwhile, increased its loan-loss reserves by $389 million in the second quarter as it expects to see rising delinquency rates for commercial mortgages tied to office properties.
“Our office [commercial real estate] portfolio is quite small and our exposure to urban, dense offices is even smaller,” JPMorgan's Chief Financial Officer Jeremy Barnum said during a Friday conference call. “But we like to be ahead of the cycle and, based on what we saw this quarter, it seemed reasonable to build the reserve.”
JPMorgan did not break out loan balances by property types in its commercial real estate loan book. The bank’s executives did not comment during the call on other property types in its commercial mortgage portfolio.
JPMorgan expanded its commercial real estate loan portfolio by 32% in the second quarter from the first quarter, with nearly all the growth stemming from its May takeover of First Republic Bank. JPMorgan acquired most of the assets and deposits from the failed First Republic after California regulators closed it because of problems caused by higher interest rates.
JPMorgan — already the nation’s largest bank by total assets prior to the First Republic deal — added $34.3 billion in loans to its commercial real estate portfolio in the second quarter for a total of $142.9 billion. Of the added funds, $33.3 billion was from the First Republic acquisition and $1 billion was internal loan growth, according to regulatory filings.
Even with the First Republic deal, JPMorgan is still the nation's second-largest lender of commercial properties. Wells Fargo remains No. 1 with $154.3 billion in commercial real estate loans as of the end of the second quarter.