What Does PNC Financial Say About Commercial Real Estate?

December 12, 2023 | 両替料 | For some time we’ve been meaning to return to PNC Financial (PNC), the eighth largest bank in the US right behind U.S. Bancorp (USB) at just over $600 billion in assets. When we looked at PNC back in January of 2023 (“Update: Truist, Charles Schwab, U.S. Bancorp & PNC Financial”), the bank’s credit profile was pristine. Yet by October 2023, PNC reported its non-performing commercial real estate (CRE) loan balance more than doubled to $723 million in the third quarter from $350 million in the second quarter. PNC stated during their conference call:

Reading the latest comment from Bill Moreland at BankRegData, it seems that the carnage in commercial real estate is starting to bleed through into bank public disclosure and soon earnings. What does PNC tell us now about commercial loan exposures in 2024 and beyond? The chart below shows loss given default (LGD) for the $500 billion in bank owned multifamily commercial mortgages.

Source: FDIC/WGA LLC

PNC is a significant commercial lender with a national portfolio and also a significant loan servicing business in both residential and commercial assets. The $557 billion asset bank provides a good surrogate for bank exposures in the commercial sector. Bill notes in a 12/6/23 comment to his clients that PNC’s commercial real estate exposures are starting to show mounting levels of stress and, of course, forbearance in the form of troubled debt restructurings (TDRs). 

“Starting with Non Owner CRE on the left it's fairly clear that PNC has a significant NPL issue,” Bill writes. “NPLs have leapt from $181.7 million in 2022 Q4 to a staggering $722.8 Million in 2023 Q3. The NPL % went from 0.97% to 4.04% - a doubling and then another doubling. While stunning, Citi and Goldman Sachs also experiencing similar issues.”

As the chart below from the bank's Q3 2023 earnings presentation illustrates, PNC has done a good job of repricing its balance sheet over the past year and more, but commercial credit risk remains the largest exposure for the bank. We assume that 2024 is going to see rising levels of delinquency for commercial credits, both at PNC and other large regional lenders.

Readers will  recall that we have noted outlier credit loss behavior from both Citigroup (C) and Goldman Sachs (GS) for some time.  The developments at PNC, however, track the recent market reports on distress in a wide variety of CRE assets across the banking industry. That is, if PNC is seeing a surge in delinquency in its CRE portfolio, then you can be pretty sure that other regional banks with significant CRE exposures are seeing the same.

In its Q3 2023 Form 10-Q, PNC reveals a 41% increase in non-performing loans, which now includes “Troubled Debt Restructurings and Vintage Disclosures, nonperforming loans as of September 30, 2023 include certain loans where terms were modified as a result of a borrower’s financial difficulty. Prior period amounts included nonperforming TDRs.”

As with retail consumer facing exposures, banks are using TDRs more and more to avoid foreclosure on commercial borrowers. Similar to a consumer default, the idea of a TDR is that processing the foreclosure is more costly than keeping the borrower in place at a lower interest rate.  The only problem is that the bank’s portfolio becomes impaired with weak assets that are now TDRs and may or may not be fully disclosed. As we've noted with the Ginnie Mae exposures of Texas Capital Bank (TCBI), litigation can be used as a reason to delay disclosure.

PNC states in its most recent 10-Q:

Moreland notes, for example, that tracking the movement of NPLs, TDRs and actual charge-offs of delinquent credits is neither seamless nor transparent under GAAP.  The changes visible in the CALL reports for PNC’s subsidiary bank, for example, do not necessesarily track in the GAAP disclosure. Following the movement of delinquent loans into TDR status, including assets acquired from BBVA and the FDIC from the estate of Signature Bank, makes the analysis daunting, but the bottom line seems to be higher credit loss exposures in the future for PNC.

In Q2 2023, PNC was already reporting nonaccrual loans and leases that put them in the 90% percentile of Peer Group 1.  The bank notes in the most recent 10-Q: “TDR disclosures are presented for comparative periods only and are not required to be updated in current periods. Additionally, our vintage disclosure has been updated to reflect gross charge-offs by year of origination.”

Of note, PNC shows non-performing consumer assets falling in Q3 2023 vs a year ago, a pattern consistent with the experience of other banks in the second half of the year. Commercial defaults are higher, as you’d expect, and we think that the levels reported in Q4 and 2024 are likely to be significantly higher. The volume of loan defaults and restructuring in commercial assets is unprecedented and is likely going to increase in volumes and net loss rates next year. Table 42 below shows PNC's nonperforming assets.

Table 58 below from the most recent PNC 10-Q shows the reconciliation for loan loss provisions for loans and also unused credit lines, “exposure at default” in the language of Basel III. Of note, PNC has $42 billion in delinquent consumer loans and almost $60 billion in delinquent commercial exposures that it services for third parties. PNC owns $1.1 billion in commercial mortgage servicing rights (MSRs) and $2.3 billion in residential MSRs, in both cases double the levels of a year ago. Advances on these assets are not yet significant but warrant close attention going forward.

PNC had a comprehensive loss on securities of $14.9 billion at the end of Q3 2023, which is roughly a third of the bank’s tangible equity. The bank’s commercial loan book was $174 billion at the end of Q3 2023, down from $182 billion at the end of 2022. The bank’s residential loan book is just $47 billion, by comparison, and has strong FICO and loan-to-value (LTV) metrics.  Apparently, PNC is deliberately managing down CRE exposures and increasing consumer loans.

Bottom line on PNC and other regional lenders: Defaults in CRE are headed higher, both for loans that are disclosed and loans that are "managed" or subject to modification via a TDR. For every commercial loan being walked to the curb for disposal, there are several more in the portfolio being managed. Because CRE loans are all different and because most commercial loans have some degree of real estate exposure, the wave of CRE losses facing banks like PNC over the next several years could be significantly larger than expected by many analysts.

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