Even cherry-picked office loans are causing problems for banks

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Despite strong deal metrics, a recently booked loan involving a Boston office building has lead to headaches for Westerly, Rhode Island-based Washington Trust.

Usually, banks aren't penalized for making good loans. In 2023, though, if the deal involves an office building, investors and analysts are liable to give it the evil eye. 

That appears to be what has happened to Washington Trust Bancorp. The 223-year-old Westerly, Rhode Island-based company saw its share price plummet after reporting third-quarter results that exceeded analysts' earnings-per-share forecast by a substantial margin. 

The $7.2 billion-asset Washington Trust posted earnings of $11.2 million, or 65 cents per share Monday. Analysts had been expecting about 58 cents per share. Nevertheless, the company's shares fell nearly 9% in the wake of the report. The discount remains in effect, with shares trading at $21.77 Friday afternoon. The stock started the week at $24.58.

One  likely culprit: a recently booked office loan Chief Risk Officer Bill Wray described as "a real cherry to pick," due to exceptional deal metrics. "This is one we felt it was the right thing to do," Wray, who has served as Washington Trust's chief credit officer since June 2015, said Tuesday on a conference call with analysts. "It had… about a 50% loan-to-value, two times [debt] coverage, no tenant concentrations. So it was a deal that made sense." 

The loan led to an 8% linked-quarter boost in the dollar size of Washington Trust's office portfolio at a time when most banks are closely scrutinizing the category. Indeed, in August, the Federal Deposit Insurance Corp. flagged office loans as an area of concern in its 2023 Risk Review.  A number of lenders, including Toronto-based CIBC and Wells Fargo, have announced plans to increase reserves or de-emphasize office lending due to the sector's worsening outlook.

The growing popularity of remote work has led to an uptick in vacancies, as well as fears lenders heavily invested in office loans could see big losses in the not-too-distant future. 

Against that backdrop, it isn't surprising, perhaps, that analysts and investors noticed size of  Washington Trust's office portfolio jumped from 52 loans totaling  $267.2 million on June 30  to 53 loans for $289 million three months later. The portfolio totaled $257.6 million at Dec. 31, 2022.

"I'm sort of scratching my head," Mark Fitzgibbon , who covers Washington Trust for Piper Sandler, said Tuesday on the conference call. "You guys have grown your office loan portfolio this year by 12%. It just seems like an inopportune time to be doing that."

Seaport Research Partners Analyst Laurie Havener Hunsicker noted Chief Financial Officer Ron Ohsberg said on the conference call that Washington Trust has no plans to grow its office book outside the one recently added loan. Still, Hunsicker wrote Thursday in a research note that she was "deeply disappointed to see this loan added at a time when it is prudent to scale back this loan category." The loan involves a Class-A building in downtown Boston, according to Hunsicker.

While the industry's asset quality held up relatively well in the third quarter, office loans produced credit hiccups at several banks. Troubled office loans contributed to the jump in nonperforming assets that the $111.2 billion-asset, Hicksville, New York-based New York Community Bancorp reported Thursday. The $13.5 billion-asset OceanFirst Financial in Red Bank, New Jersey, meanwhile, recorded a $17 million charge-off tied to a loan secured by an office building in Manhattan. 

For its part, Washington Trust has yet to see any significant deterioration in its asset quality. Though nonaccrual loans did jump by $23 million during the third quarter, they remain low in absolute terms totaling $33.7 million or 0.60% of total loans at Sept. 30. Moreover, the two loans that contributed to the third-quarter jump in nonaccruals are both current in their payments, according to Ohsberg. 

The Kroll Bond Rating Agency cited Washington Trust's "solid long term asset quality performance, underpinned by disciplined underwriting standards," in a September 11 research report. Hunsicker agreed, highlighting the company's "solid credit and a near perfect historic credit scorecard," in her research note. Hunsicker termed the office-related selloff an "opportunity" to acquire Washington Trust shares at a bargain price. 

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