Regional banks in the US and even some large international banks are facing substantial losses from loans made over the past decade to US commercial real estate projects, especially office buildings, that are now suffering from vacant space and falling rents.
Japanese Bank Aozora Takes Big Hit
On Thursday, Japanese bank Aozora warned that it expects to book its first net loss in 15 years, largely due to writing down the value of its US commercial property loan portfolio by $488 million.
Aozora was an aggressive lender to US commercial real estate projects, with nearly a third of its $28 billion loan book tied to US offices and apartment buildings. With the pandemic-driven shift to remote work cutting demand for office space and rising interest rates softening rents for urban apartments, vacancy rates have spiked while rents and property valuations have declined.
The bank’s shares plunged 19% on Thursday to their lowest level since 2021 on the news. Analysts were caught off guard by the size of the impending writedown and expect Aozora may need to take further losses if US commercial property valuations fall further.
Regional US Banks Also Exposed
Aozora is not the only bank feeling the pain from souring US commercial property loans. Many regional and community banks in the US hold significant exposures to CRE loans as well, especially to office buildings, hotels, and retail properties.
With the US economy slowing and demand for office and retail space shrinking, delinquencies are rising rapidly. According to data from Trepp, delinquency rates on commercial real estate mortgage-backed securities hit 8.2% in December, up from just 1.7% a year ago. And that is likely understating the true extent of stress, as many loans have been granted forbearance or modified to avoid recognized delinquencies.
| Commercial Property Type | Delinquency Rate |
|---|---|
| Lodging | 17.4% |
| Office | 11.9% |
| Retail | 10.7% |
Already several banks have been forced to cut dividends, raise capital, or curtail lending in order to shore up their balance sheets for coming commercial real estate losses.
Risks Extend to Money Center Banks Too
Even large money center banks like Citi, Wells Fargo, and Deutsche Bank have meaningful commercial real estate exposures that could lead to losses if the downturn deepens further.
Deutsche Bank warned last week that it may need to increase provisions against expected CRE losses by over $500 million. And Wells Fargo’s CEO recently called out increased delinquencies on CRE loans as an area of focus.
Outlook Remains Cloudy
With high inflation, rising interest rates, a slowing economy, and remote work still prevalent, the outlook for demand recovery in much of the US commercial property sector remains poor. Vacancy rates are expected to rise further in 2023, putting additional pressure on rents and property valuations.
As a result, mounting losses for US and international banks tied to souring CRE loans appear inevitable in the coming quarters. Analysts expect more dividend cuts and capital raises may be needed to shore up bank balance sheets enough to weather the storm.
The eventual extent of losses and impact on bank lending capacity will depend on how deep and prolonged the commercial real estate downturn becomes. But already substantial losses realized by some exposed institutions highlight it as an area of rising risk for the banking sector.
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