Concern about the effect of commercial real estate loans on U.S. commercial banks has been ongoing for years. However, growing evidence has been that conditions might not be as bad as many thought.
A new report from S&P Global Ratings said that the chance of CRE loan problems creating significant creditworthiness problems for banks “has declined.”
That doesn’t mean CRE problems are unlikely to continue negatively affecting credit metrics for U.S. banks over the next few years. They probably will. “However, in our view, the probability that problems in CRE will lead to a material weakening in the creditworthiness of rated banks has declined over the last year,” the company wrote. “This led us to revise our outlooks to stable from negative on six banks with material CRE exposures.”
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Quantitatively, 90% of the banks that S&P Global rates are “positioned for the challenges in the year ahead.” The firm expects Federal Deposit Insurance Corp.-insured banks, in general, to see a “decent” 10.5% to 11.5% return on equity in 2025.
S&P Global sees six key reasons why U.S. banks should be able to weather CRE risks. The first is the state of the overall economy, which the credit agency expects to see 2% growth in the next two years with an unemployment rate that will tick up but remain at a historically low 4.2%.
Valuations of office CRE properties, which have proven the greatest worry in the industry, seem to have stabilized, according to Green Street data. Overall, CRE property prices are down 18% since the 2022 peak. Office fared the worst with a drop of about 36%, however, they fell only 1% during 2024, moving to stability. Valuations of multifamily, industrial, and retail were up during last year but still down from 2022. “We believe what's helping valuations are a combination of the Fed rate cuts, a drop in interest rates from their peak, and ongoing economic growth combined with low unemployment,” they wrote. Also, it’s good to remember that values in 2022 were arguably part of an unsustainable bubble, given the dependence on liquidity injections from the Fed and virtually zero interest rates.
Banks have reduced their exposure to office loans, and the latter represent a “relatively small” percentage of loans. The largest banks saw non-owner-occupied CRE representing about 11% of their loans. For smaller banks, including many that S&P Global doesn’t rate, the exposure is about 38%. For rated banks, it’s 19%. And office exposure is only a low-to-mid-single-digit percentage of all loans.
The asset quality has improved. CRE past due and nonaccrual loans were about 1.7% of all CRE loans at the end of 2024, up from 1.2% at the end of 2023. CMBS delinquency rates were 5.6% in December 2024. Bank CRE charge-offs were 1.9% for 2023 and 2024 together. FDIC-insured banks reported that about 0.9% of their CRE loans were modified as of the end of 2024, suggesting that most of the matured loans were refinanced or paid off without modification.
Bank balance sheets improved between 2023, when industry deposits reached a low of $18.3 trillion in Q3, to above $19 trillion at the end of 2024. Unrealized losses in bank securities portfolios declined from $685 billion (12%) in 2023 Q3 to $485 billion (6.5%) in 2024 Q4. About 80% of S&P-rated banks reported an increase in common equity Tier 1 ratios last year to 13.0%, up from 12.3% at the same time in 2023.
Finally, S&P Global expects “solid profitability” of 11.5% return on equity from 2024 as earnings reports happen and an industry ROE of 10.5% to 11.5% in 2025.
There are still headwinds. Policies of the new administration could increase inflation, which has already caused the Fed to further put off rate cuts and could, if bad enough, even raise them. There are $4.5 trillion in CRE loans, and not just from banks, that need refinancing by 2028. Banks might also not see sufficient loan growth, straining profitability.
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