Gruenberg: Banks face credit risks from loss of office space

Martin Gruenberg

The reduction in occupied commercial real estate space caused by a mass shift to remote work poses credit risks for banks, FDIC Chair Martin Gruenberg said in a March 7 speech during an Institute of International Bankers conference. 

The national average vacancy rate increased to 12.5 percent by the end of last year from 9.6 percent in March 2020. As of the fourth quarter of 2022, five major metropolitan areas had office vacancy rates of between 15 and 20 percent, Gruenberg noted. Approximately $56 billion or 37 percent of the $152 billion in overall loans financing properties are due by 2032. Gruenberg said rising interest rates are also posing risks for banks in CRE lending.  

“Some of the loans financing these properties are whole loans held on the balance sheets of banks, some are syndicated and sold and many serve as collateral for commercial, mortgage-backed securities,” Gruenberg noted. “There are early indications that delinquencies on office properties CMBS are starting to tick up.” 

As more employees work remotely following the pandemic, top-tier Class A building office space will continue to prosper, but Class B and C properties will not, Steelbridge Founder and Managing Principal Gavin Campbell said last month during a virtual forum hosted by Chicago-based financial advisory firm D.A. Davidson. 

Properties in the southwestern U.S. and along the coasts will be in a good position but secondary cities in the Midwest will not, he added. Campbell noted that the drop in CRE space has been occurring for decades. In the early 1980s, the average rentable space per employee was 500 square feet. Today, that number is 180-200. 

There are positive signs in the CRE market. Bank CRE lending increased by 10.7 percent last year, and commercial and deposit lending grew by 16.5 percent. According to S&P Global, the delinquency rate on CRE loans at U.S. banks increased in the fourth quarter of last year after falling sharply during the third quarter. 

Loans more than 30 days past due and those in nonaccrual status constituted 0.65 percent of CRE loans, up from 0.58 percent at the end of September. Despite the uptick, the CRE loan delinquency rate is six basis points lower than at the end of 2021. The number of U.S. banks exceeding regulatory guidance on CRE loan concentration either through two thresholds — construction loans being at least 100 percent of risk-based capital or at least 300 percent of risk-based capital levels — grew for the seventh straight quarter, to 567. That number was 421 a year ago.

Gruenberg said higher interest rates have had “dramatic effects on the profitability and risk profile of banks’ funding and investment strategies.” Banks had an estimated $620 billion of unreleased losses, including securities available for sale or held to maturity, at the end of last year.  “Longer-term maturity assets acquired by banks when interest rates were lower are now worth less than their face values,” he added. “The result is that most banks have some amount of unrealized losses on securities.”

Gruenberg said banks will need to pay more interest to retain their deposits, or accept some deposit outflows. “We have seen modest decreases in total deposits and modest increases in insured deposits,” he added. “In aggregate, meaningful deposit outflows have not yet materialized, but banks will need to watch these trends carefully as the interest rate environment evolves.”