🔒Banks keep closer eye on office property loans amid sector’s slow recovery

Some Connecticut banks are seeking to insulate themselves from the struggling office real estate market that’s been battered by employers’ post-pandemic embrace of hybrid or remote work.

Stamford-based Webster Financial Corp. in late January reported significantly higher fourth-quarter profits, despite $20 million in loan charge-offs.

About half of the charge-offs came from office loans, two of which were proactively sold, according to Webster Financial President and CEO John Ciulla.

Ciulla told investors during a Jan. 26 earnings call that Webster, with $71 billion in assets, has been closely monitoring its office loan portfolio that is split evenly between higher-quality Class A properties and less luxurious Class B and C buildings.

It’s sold off some of those loans, while its overall office portfolio has shrunk from $1.7 billion to $1.5 billion, he said.

“We haven’t seen any material deterioration in the portfolio and what we’ve been doing is kind of selecting those Class B and Class C office loans … and looking at them and trying to think about whether or not there is particular vulnerability, and then seeing whether or not we can exit those credits … before maturity,” Ciulla told analysts.

He added: … “we’ve seen stabilization in the general credit characteristics of that portfolio, but we still are, like everyone else, concerned about the long-term nature of that asset class.”

Higher vacancies, more risk

A move toward remote work has caused demand for office space to shrink dramatically in many U.S. markets with companies choosing to downsize their footprints as workers meet in person on a more infrequent basis.

The U.S. office vacancy rate hit 19.1% at the end of the third quarter of 2022, according to the New York Times, while a new report from brokerage firm Cushman & Wakefield forecasted that 330 million square feet of U.S. office space could become vacant by the end of the decade.

At most risk of vacancy are older, Class B and C properties that lack the amenities companies and their workers increasingly desire, the report said.

In Greater Hartford, 21.5% of the region’s 25.9 million square feet of office space was vacant at the end of the fourth quarter, while 27.3% was available for lease, according to brokerage firm CBRE.

Downtown Hartford’s overall office vacancy rate stood at 27.1% at the end of the fourth quarter, while center-city Class A buildings had a 27.1% vacancy with 34.6% of space available for lease, CBRE data shows.

Banks that carry significant office assets are closely monitoring vacancies and leases, particularly with recent examples of major office landlords defaulting on loans.

For example, global asset manager Brookfield Corp. recently defaulted on $755 million in loans on two, 52-story office towers in Los Angeles, according to published reports.

Meantime, the delinquency rate for office loans backed by mortgage-backed securities, while still relatively low, increased a quarter percentage point in January to 1.83%, the Wall Street Journal reported, citing data from Trepp Inc.

That was the largest delinquency rate increase since December 2021, the Journal reported.

Many large banks last quarter also set aside more money to cover loans they expect to go bad in the future, according to S&P Global.

In downtown Hartford, at least one major office building — the Stilts Building at 20 Church St. — has fallen into foreclosure.

During New York-based M&T Bank’s fourth-quarter earnings call, Chief Financial Officer Darren J. King said office space is a clear area of concern.

King said his $200.7-billion asset bank, which has a major Connecticut presence following its $8.3 billion takeover last year of Bridgeport-based People’s United Bank, has seen moderating risk in its hotel portfolio, but concern for an increasing portion of its nursing home and office loans.

M&T had about $5 billion in office loans as of the fourth quarter, about 20% of which was “criticized,” or in danger of default, prompting the bank to keep close watch on lease expirations and sign-ups, King said.

There has been “decent” renewal activity and some downward movement in rents, King noted.

“If we talk about our expectations for charge-offs … as we go into this year, that’s the place where we’d have the most concern,” King said, referring to office loans.

King said recent tech-sector layoffs might drive people back to the office. He is more confident that younger workers eager to advance their careers will ultimately lead the return to offices.

“Is it five days a week, probably not, but it’s not going to be zero, at least this is Darren’s opinion,” King said.

Michael Weinstock, M&T’s Hartford regional president, said his bank hasn’t changed underwriting standards for office loans. The bank makes loans based largely on long-term customer relationships, which builds in its own security, he said.

“We generally have been down the road with our clients for some time,” Weinstock said. “These are relationships as opposed to an investment in an asset class.”

Community bankers optimistic

Ion Bank President and CEO David Rotatori said Webster’s recent charge-offs made him ponder if his bank should take another look at its office exposure. The Naugatuck-based bank, with $2.1 billion in assets, recently completed a “thorough” review of all commercial loans over $500,000, finding “very few” at any risk, he said.

“We did talk about some of the office challenges, but we didn’t see any that we felt warranted a write-down right now,” Rotatori said.

Rotatori said Ion has not changed its already-conservative office loans underwriting criteria. As a mutually owned bank, Ion doesn’t need to manage shareholder expectations and is less likely to take preemptive action, Rotatori said.

Nick Caplanson, president and CEO of Norwich-based Dime Bank — a mutual lender with $1.1 billion in assets — acknowledged the turbulence in the office market, but said his bank would not shy away from well-founded office loans. Caplanson said Dime Bank is maintaining already conservative commercial lending standards.

“While I clearly agree the commercial office market has softened up, we have not seen any deterioration in our portfolio whatsoever,” Caplanson said. “Part of that is how we approach underwriting of these loans. It’s a little more conservative than national and regional commercial lenders.”

Caplanson said his bank’s experience with its $450 million commercial loan portfolio — 13% of which is office loans — might run counter to the widespread concerns raised in the national press.

“They are waiting for the shoe to drop,” Caplanson said. “Well, it hasn’t dropped here. And I don’t see it even looking like it is going to drop.”