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The U.S. Federal Reserve’s latest report shows growing concerns over loan delinquencies in the office and multifamily sectors, while reassuring that the banking system remains overall sound and resilient.
The report, part of the Fed’s twice-yearly supervision and regulation review, identifies increasing distress in commercial real estate (CRE) loans, particularly in office buildings, where delinquency rates surged to 11% in the second quarter. The multifamily sector has also experienced a steady rise in delinquencies, according to BisNow.
The Fed attributed much of the deterioration in loan performance to larger banks, though smaller banks have also seen an uptick in delinquency rates in 2024.
Despite these signs of stress, the central bank emphasized that most financial institutions are in a strong position, with ample capital and liquidity.
“The banking system remains sound and resilient overall,” the Fed stated, noting that most banks have strong reserves to cover potential credit losses.
However, the Fed’s report underscored that credit performance in certain lending sectors, particularly commercial real estate and consumer lending, continues to show weakness.
As a result, banks have been increasing their credit loss reserves to prepare for potential losses.
The office real estate market, in particular, faces considerable challenges.
High interest rates, slower economic growth, tighter lending conditions, and declining office space demand are contributing to the sector’s struggles.
Fitch Ratings had already flagged a deteriorating outlook for office loans in June, raising its delinquency forecast for office commercial mortgage-backed securities (CMBS).
In addition to office sector woes, the multifamily sector is also under pressure. According to CRED iQ, around 7.4% of apartment CMBS loans were either delinquent or in special servicing as of July, up sharply from roughly 3% at the beginning of the year.
The Fed attributes the multifamily sector’s troubles to slower revenue growth, higher operating costs, and falling property valuations.
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In response to the broader economic conditions, the Fed also shared the results of its latest stress tests, which assess how well large financial institutions can handle adverse economic scenarios.
One third of the largest banks passed all three categories — capital planning, liquidity risk management, and governance. However, the report revealed that many banks still show weaknesses in managing interest rate risk and liquidity risks.
For the first half of 2024, banks reported $203 billion in fair value losses on securities available for sale, a slight improvement from the $248 billion loss reported in the same period in 2023.
Similarly, losses on held-to-maturity securities remained stable at around $308 billion. Despite these losses, the stress tests concluded that large banks would be able to withstand a severe recession scenario and remain above required capital thresholds.
Looking ahead, the Federal Reserve’s supervisory focus will remain on improving credit risk management practices, particularly in credit card and commercial real estate lending.
As the economy continues to face challenges, the Fed’s vigilance in overseeing these risks will be key to ensuring financial stability in the coming months.
