JP Morgan Chase (JPM.N) and Wells Fargo (WFC.N) announced on Friday that they have increased their provisions for potential losses from commercial real estate loans, highlighting the growing concerns in the sector. The global commercial real estate market, particularly office buildings, has been under pressure due to high interest rates and the continued remote work trend, according to a report by Reuters.
Wells Fargo reported higher losses in commercial real estate (CRE) due to its office loan portfolio and raised its allowance for credit losses by $949 million. However, the bank also noted that its CRE revenue increased to $1.33 billion compared to the previous quarter, primarily driven by higher interest rates and loan balances. Wells Fargo CEO Charlie Scharf acknowledged the anticipated market weakness and stated that they are reserving for the expected losses.
JP Morgan saw its CRE revenue grow from $642 million in the first quarter to $806 million in the second quarter. The bank, which acquired First Republic Bank in May, reported $1.1 billion in credit loss provisions primarily related to its office portfolio. Despite the relatively small size of its office portfolio, JP Morgan CFO Jeremy Barnum explained that they decided to increase provisions to ensure a comfortable coverage ratio based on their assessment of the quarter’s performance.
While the U.S. Federal Reserve’s stress tests showed a slightly improved outlook for big banks’ CRE exposure compared to the previous year, the majority of office and downtown CRE loans are held by smaller regional and community banks, which have less stringent capital buffers, as noted by the central bank. Regulators have been closely monitoring CRE risks, particularly at banks with a high ratio of such loans to their total capital, while lenders have been working with borrowers to prevent defaults.
Wells Fargo’s CFO, Michael Santomassimo, mentioned various structural enhancements and partial paydowns as strategies to manage CRE risks. CRE borrowers have faced challenges with higher refinancing costs as property values declined and interest payments increased. Real estate data provider Trepp revealed that approximately $20 billion of office commercial mortgage-backed securities are set to mature in 2023.
According to a report from the McKinsey Global Institute, office property values in nine major U.S. cities could decline by $800 billion over the next seven years. In a moderate scenario, McKinsey predicted a 13 percent decrease in demand for office space in 2030 compared to 2019. San Francisco’s office market has experienced significant setbacks, including several major loan defaults this year. However, Santomassimo noted that Wells Fargo has successfully worked out some of the loans in its portfolio even in California, which accounted for almost a third of the bank’s outstanding office CRE loans.
Overall, the outlook for the commercial real estate sector remains uncertain, and banks are taking precautionary measures to address potential losses and support borrowers facing challenges in the market, stated Reuters.