Five things to know about Q2 bank earnings 

Second quarter earnings from major US banks including JPMorgan Chase, Wells Fargo, Citigroup and Goldman Sachs Citigroup have a few key takeaways for the commercial real estate debt market.

While the sector appears more stable, banks are bulking up their reserves in anticipation of losses in their office loan portfolios. Additionally, regional and national banks are also unlikely to return to commercial real estate lending at scale anytime soon, said Ran Eliasaf, founder and managing partner of Northwind Group, a debt-focused commercial real estate private equity firm in New York. 

Here are five things market participants are saying about this quarter’s earning seasons. 

1. Rising profits

On its second quarter earnings call on July 14, JPMorgan reported a 67 percent increase in profits to $14.5 billion. The increase was fueled in part by the New York-based bank’s acquisition of First Republic Bank in May as well as a higher interest rate environment, officials on the call told investors.  

“I think JPMorgan and the other big banks really benefitted from what happened after the crash of Silicon Valley Bank, Signature Bank and First Republic Bank. Deposits left these smaller banks, and other local and regional banks, and moved to the bigger banks,” Eliasaf said. “Their balance sheets and deposit bases actually increased way more than they expected this year.” 

2. Rising concerns 

The flip side of rising profits is concerns over commercial real estate holdings. New York-based Goldman Sachs has seen $305 million worth of losses in its private portfolio, primarily due to write-downs of office properties, chief financial officer Denis Coleman told investors on last week’s earnings call. Debt investments revenues also declined year-over-year because of weaker performance in real estate markets, he added. The firm did well to stave off complete negativity, however.  

Goldman added a slide to its earnings presentation for the first time highlighting its $178 billion loan book. It noted that only 15 percent, or $28 billion, of the loans were exposed to commercial real estate, with only 1 percent of that to office, the market’s least favorite asset class currently. That percentage is down from just over 18 percent at the same time last year. 

3. Lower lending volumes 

The flip side, however, is that smaller, regional banks have lost deposits, which is leading to a credit crunch for middle market commercial real estate borrowers, Eliasaf added.  

“This is being felt by borrowers on the senior debt side as these smaller banks have all but stopped lending,” Eliasaf said.  “The bigger banks have increased their deposits and can give out loans at higher spreads and better margins, which is a healthier situation for them. “It is not a great situation for smaller banks,” he added. 

4. Alternative lenders step in 

As banks scale back their lending, alternative lenders are picking up their pace.  

Northwind, as a private lender, is seeing more deal flow and can be more selective on the loans it chooses to move ahead with. “There’s less competition and there is more need for financing solutions,” Eliasaf said. “The general environment is riskier, so as a lender you must be more careful. One thing that is harder is figuring out the value of real estate.”

5. Regulation on the horizon 

Earnings season comes against the backdrop of the Federal Reserve’s annual stress tests for banks. All 23 banks in this year’s iteration cleared the Federal Reserve’s hurdles, according to a report published this week from Toronto-based rating agency DBRS Morningstar. 

 The sector had preliminary stress capital buffers of 2.5-5.5 percent, the report stated. “Overall, projected CRE loss rates remain elevated but have fallen since 2020 as the hospitality sector recovered from the acute pandemic-related stress,” said John Mackerey, a senior vice-president at DBRS covering North American financial institutions. 

Despite this, the Federal Reserve is calling for more stringent regulation in the sector, a shift that could result in higher debt costs for commercial real estate borrowers and reduced lending capacity for these banks. In his July 10 remarks, Michael Barr, vice-chair for supervision, proposed changes that would lower the threshold for long-term debt and risk capital requirements to apply to banks with $100 billion in total assets compared with the current $700 billion mark.  

What’s next 

In Eliasaf’s view, some of the concerns around the banking sector have been mitigated.

“The real question is how the balance sheets of these smaller banks will look with exposure to longer-term, fixed-rate loans on office, multifamily or properties in other sectors,” Eliasaf said. “I’m still concerned that some banks have large exposures to troubled loans that haven’t come out yet and I’m not sure the volatility is entirely over. There are still some toxic assets and bad loans, and the magnitude of the impact is yet to be seen.” 

The magnitude of the impact on commercial real estate also remains to be seen, with Eliasaf noting the market continues to see tepid transaction volume and the expectation of a further decline in valuations. “How steep that decline will be, no one knows,” he said. “But once we realize how big of a correction it is, then we’ll realize how big of a recession we’re talking about, or just maybe a few bank failings and but not nothing systemic.”