Empty office space

As the monetary environment tightens, smaller U.S. banks are increasingly vulnerable to deteriorating conditions in commercial real estate, says Fitch Ratings.

In a new report, the rating agency said banks with less than US$100 billion in assets have higher exposure to declining fundamentals in the commercial real estate sector, which could translate into increased pressure on their credit ratings.

Commercial real estate is facing pressure from tightening market conditions, which is impacting the value of collateral and transaction volumes, even as the demand for office space in particular is easing, it noted.

“These factors increase credit risk for banks that have [commercial real estate] loan concentrations, and are expected to have an impact on asset quality in [the] loan portfolios of U.S. banks,” Fitch said in its report.

In particular, banks with higher exposure to office real estate in markets with weaker occupancy trends — such as San Francisco, Houston, Dallas, Chicago and Washington, D.C. — will face “moderate stress over the near to medium term,” it said.

For larger banks, exposure to office real estate represents just 1% of assets in aggregate, and is “not expected to impact ratings over the near term,” Fitch said.

Ultimately, the impact of commercial real estate loan performance on earnings and capital will “vary considerably across the banking industry, depending on geography and type of underlying properties which drive rents, occupancy and ultimately debt service coverage ratios for banks,” it said.