Since the banking crisis began, investors have been examining bank balance sheets extra closely, which has renewed focus on banks' exposure to commercial real estate (CRE), especially as credit quality deteriorates and a potential recession looms.

The $203 billion-asset M&T Bank (MTB 0.76%) has quite a bit of CRE exposure when you compare it to its peer group, with total CRE loan exposure a little bit below 300% of its core capital, which is about the level that starts to draw attention from regulators.

Given broader concerns about CRE and M&T's exposure, let's take a look at how credit quality is holding up after the bank's first-quarter results.

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On solid footing

At the end of the first quarter of 2023, M&T's commercial real estate portfolio stood at about $45.1 billion. Although the various subcategories aren't broken out, we know from the bank's regulatory filing for full-year 2022 that roughly 14% of the portfolio was in retail/services, 13% in multifamily housing, 12% in office properties, 8% in health facilities, and 6% in hotels.

At the end of the quarter, the net charge-off rate at the bank, which looks at M&T's total expected loan losses as a percentage of total loans, rose from 0.12% at the end of 2022 to 0.22%. Total non-performing assets increased about 5% and the bank raised its provision for future credit losses from $90 million in the fourth quarter of 2022 to about $120 million in Q1. Overall, there was a rise in expected loan losses, non-performing assets, and the loan-loss provision, but it's really nothing to be overly concerned about at this point. Credit quality has been so benign that a return to more normal levels of troubled loans was going to happen at some point.

M&T Chief Executive Officer Darren King said that roughly half to two-thirds of the $120 million provision was tied to CRE loans. King also said the office loan portfolio remains about 20% criticized, which is up slightly from the sequential quarter. Criticized loans are those that management believes may default or miss a loan payment in the future even though they may not have shown up in a bank's delinquencies just yet. But King added that criticized hotel loans continue to come down, and there's also been some improvement in retail and multifamily remains in good shape as well.

Homing in on office

The biggest concern in CRE right now is arguably office space (not that investors aren't worried about other CRE segments as well).

But office space is a big focus because there has been a fundamental shift in the way people work, with many people continuing to work remotely. This has led to rising office vacancy rates and is likely to result in less demand for work space, which in turn is likely to lead to a decline in office building property values.

While investors are braced, the losses in office loans could be more of a slow burn because they mature at different times and tend to be on longer leases. King said the bank will see about $200 million worth of office loans mature over the next two quarters, which isn't a lot considering the bank has a roughly $5 billion office loan portfolio. Then after the next two quarters, even fewer office properties will mature in the near term. King said roughly 75% of office loans won't come due until after 2024, so the bank does have time to prepare.

But overall King feels pretty good about the portfolio because a lot of these loans have been underwritten with loan-to-value (LTV) ratios of below 60%. The LTV looks at the value of the loan compared to the value of the property, so the smaller the LTV, the more equity a borrower has in the property. King said that properties are getting reappraised and values on the reappraisals have fallen about 15% to 20%, but the low LTVs still leave some good equity cushion before losses start to kick in.

A good track record to work off of

King acknowledged that CRE exposure and office loans are a mounting concern and something that the bank is watching, but this is definitely not an issue that will play out overnight.

Furthermore, time is on the bank's side. Management, which has historically been a good underwriter of credit, can proactively prepare for office loans to come due. Given its larger exposure among its peer group, CRE loan performance is definitely going to impact M&T's stock, so certainly watch for updates every quarter, but M&T's exposure seems manageable right now.