Big Banks Real Estate Challenges

According to a recent analysis by S&P Global Ratings, the largest U.S. banks are facing some challenges when it comes to office real estate exposure. However, they are considered big enough to handle the situation.

Key Findings of the Analysis

After examining fourth-quarter updates from major U.S. banks including JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., and others, S&P concluded that these institutions, known as global systemically important banks, are crucial players in the country's financial landscape.

In addition to the significant players like Bank of America and JPMorgan Chase, S&P also considered Northern Trust Corp. in its assessment due to its peer relationship with custody banks like State Street and BNY Mellon.

Challenges and Future Outlook

Although 2023 posed challenges due to various factors such as interest rate hikes, a decline in mergers and acquisitions, and the closure of regional lenders like Silicon Valley Bank, more obstacles lie ahead. One of the major threats identified is the decreased valuations in office real estate, partly due to the shift towards remote work post-COVID-19.

S&P noted that while office commercial real estate remains a concern, it represents only a small portion of GSIB loans. Despite being significant players in the commercial real estate lending sector in terms of dollar volumes, loans in this area constitute a relatively minor percentage of their overall portfolios, as per S&P's analysis. Commercial Real Estate Outlook

According to S&P, office properties are facing increased vulnerability due to structural changes, although they comprise a small percentage of loans. The impact of significantly higher interest rates poses challenges for both commercial real estate prices and refinancing opportunities across all property types.

Loan Performance Trends

Analyzing data from recent quarters, S&P notes that there has been a modest yet consistent increase in loss rates across all types of loans. While nonperforming and delinquent loans remain relatively low, the normalization of the credit cycle is expected to result in a gradual rise. Factors such as rising interest rates, economic slowdown, and inflation are likely to negatively impact loan performance in the near future.

Revenue Fluctuations

In 2023, trading revenue experienced a 4% decline, and investment-banking revenue saw a 10% decrease compared to the previous year. This drop was attributed to reduced client activity in response to less favorable market conditions.

Market Challenges

Fixed-income revenue saw a decline, and commodities and currencies revenue also dropped due to decreased client engagement and market instability. Despite improvements in rates, credit, and securitized products, overall trading revenue took a hit. On a positive note, equity underwriting thrived in 2023 due to increased secondary and convertible offerings, partially offsetting the decline in initial public offerings.

Financial Performance

Following adjustments for special-assessment costs imposed by the Federal Deposit Insurance Corp. related to bank failures and other factors, Globally Systemically Important Banks (GSIBs) reported strong earnings growth compared to the previous year. However, for 2024, S&P anticipates that rising credit provisions and a potential decrease in net interest income resulting from higher interest-rate payments will exert downward pressure on earnings.

Solid Profitability Prospects for GSIBs Despite Potential Earnings Dip

S&P recently stated that Global Systemically Important Banks (GSIBs) are expected to have solid profitability prospects despite a potential earnings dip in 2024. Fee income is projected to increase in segments such as mortgage and investment banking, especially if rates fall. Trading revenue is also forecasted to remain relatively healthy, exhibiting strong profitability.

Earnings Retention for Capital Accretion Amid Economic Caution

According to S&P, GSIBs are anticipated to accrue capital through earnings retention, primarily due to cautious sentiments about the economy and the Basel III Endgame proposal. This is expected to result in measured capital distributions. The proposed capital requirements allude to federal banking regulators fine-tuning the international Basel banking accords post the global financial crisis of 2007-09.

Challenges Ahead: Rising Delinquencies and Asset Quality Pressure

S&P highlighted that delinquencies and charge-offs are likely to gradually rise amidst limited economic growth, stress in commercial real estate (CRE), and declining consumer savings. The focus is particularly on price declines and maturities in CRE and credit cards, with provisions for credit losses expected to continue increasing. While asset quality pressure will elevate, it is deemed manageable.

For more on this topic, read about how Fed cop Michael Barr is defending higher capital requirements as bankers express discontent. Additionally, learn about Wall Street’s biggest banks surpassing investment-banking revenue estimates.