Reasons for Rising Delinquencies in Cre Loans

Commercial Real Estate has faced a double-barrel of headwinds coming from 1) higher rates, and 2) the work-from-home craze. Now it faces a 3rd headwind: increasing delinquencies, which of course can lead to increased defaults. But it's not that easy to see. Banks have been employing the tricks of their trade to avoid disclosing the scale and scope of the credit challenge they face. How do I know this? TDRs are going ballistic right now. TDR stands for "Troubled Debt Restructurings", also known as Loan Modifications, or Loan Mods. What happens with a TDR is the bank works out a deal with the borrower to adjust the monthly payment down, usually by offering one of 3 things: 1) a term extension, or 2) a lower rate, or 3) both. It's good for the commercial borrower because they get a more affordable payment. It's good for the bank because they can avoid reporting the loan as non-accruing or non-performing. These TDRs can continue to accrue interest. A Non-Performing Loan (NPL) no longer accrues interest. I saw some data recently on BankRegData.com which synthesizes Call Report data. The graph shows that as of Q3 2024, $9B of Non-Owner Occupied (NOO) CRE had been modified, up from only $1.3B as of Q1 2023. That's a 577% increase in modified loans, which makes up 0.77% of all NOO CRE in the US. Total NPLs in NOO CRE were 1.80% of loans as of Q3 2024, which is up from 0.54% in 2022 - a 233% increase in NPLs. But if you add all those TDRs in there, NPLs would be 2.57% of total loans. I think that from a credit standpoint it is reasonable to factor in this increase in the rate of TDRs, and comparing that to the NPL rate, when considering the credit quality of banks. If interest rates are going to stay higher for longer, it will get harder for banks to cover up this CRE problem with restructured loans. #fedpolicy #interestrates #riskmanagement

More than $1 TRILLION in commercial real estate loans coming due Extend and pretend only works for so long "...Hundreds of banks hold an outsized amount of CRE loans on their books relative to capital. Small banks (assets of $100 million to $1 billion) and midsize banks (assets of $1 billion to $10 billion) have CRE loan values far exceeding risk-based capital levels at 158% and 228%, respectively, according to The Conference Board calculations using FDIC Institutional Financial Reports data. This is compared to 142% for large banks (assets of $10 billion to $250 billion) and 56% for the largest banks (assets greater than $250 billion). The smallest banks (assets less than $100 million) issue few of such loans. As CRE property values fall and the debt service on associated loans accumulates, borrowers are becoming delinquent or defaulting. The portion of these loans that are nonperforming more than doubled — from 0.54% to 1.25% — over the six quarters from the Q3 2022 cycle low, according to data compiled from BankRegData.com and the FDIC. Compare this with the just 0.87% rate six quarters after the cycle low, in the second quarter of 2006, which preceded the 2008–09 Great Recession... ...Multiple troubled banks simultaneously raising equity capital would prove challenging and potentially destabilizing for the U.S. banking system. Any hint of doing so could cause massive depositor flight (i.e., bank runs), creating a redux of the March 2023 panic across global financial markets when only three U.S. banks came under pressure. Digital banking has accelerated the speed at which these runs might occur..." https://lnkd.in/dAxPRHqv

Office CMBS Delinquency Rate Re-Spikes to 10.6%, to Worst Levels of the Financial Crisis Meltdown - The delinquency rate of office mortgages that have been securitized into commercial mortgage-backed securities (CMBS) re-spiked by 83 basis points in May and April and at the end of May reached 10.6%, the third highest ever, just below the record in December 2024 and a hair below the two previous records during the Financial Crisis (10.7%), according to data by Trepp, which tracks and analyzes CMBS. - Since the beginning of 2023, the delinquency rate for office CMBS has spiked by 9 full percentage points. The office sector of commercial real estate has been in a depression for over two years, despite over a year of industry pronouncements that “the worst is behind us.” - More and more landlords have stopped making interest payments on their mortgages amid historic vacancy rates across the US because they don’t collect enough in rents to pay interest and other costs, and they can’t refinance maturing loans because the building doesn’t generate enough in rents to cover interest and other costs, and they cannot get out from under the building by selling it because prices of older office towers collapsed by 50%, 60%, 70%, or more. - There has been a lot of extend-and-pretend where landlords and lenders tried to just outwait the problem by extending and modifying the existing mortgage that went into default or was on the verge of default – under the motto, “survive till 2025” – with everyone hoping for much lower interest rates, and a sudden resurgence of demand for offices, both of which have remained elusive. - It’s this extend-and-pretend that has caused the CRE problems to get dragged into 2025. And the cleanup that involves recognizing big losses for investors and lenders (such as CMBS holders) has been slow. READ MORE: https://lnkd.in/g2tS5W6g

Commercial real estate. Extend and pretend. It's working, but in the face of higher rates, how much longer can some of these modified loans hold up? From the Financial Times this morning. "The number of US borrowers in danger of defaulting a second time on commercial property loans is at the highest level in a decade, raising concerns that a bank practice known as “extend and pretend” is hiding growing systemic risk." "At the end of September, the value of commercial real estate “re-defaults” was up 90 per cent in the past year through September, to $5.5bn, an increase of $1bn in the past quarter alone, according to data released earlier this week by the banks and compiled by industry tracker BankRegData." "That is the highest level since 2014 of modified, non-performing commercial real estate loans, in which a borrower was under stress, received relief — either a forgiven payment, lower mortgage rate or some other modification — and is once again delinquent." "This time around, as interest rates have risen, delinquencies and defaults have been concentrated in commercial properties — primarily office buildings that have seen a drop in tenants since the pandemic, though also malls and more recently apartment buildings." "In all, the value of rising defaults is still relatively small compared to the nearly $2tn that banks have lent into commercial property. But the value of delinquent property loans to developers and investors has risen 25 per cent to $26bn in the first nine months of this year." “We are in the early part of the curve,” said Cilik. “If we continue to see rising delinquencies we will know that these modifications are just not working out.” #cre #credit #banks #creditunions BankRegData.com https://on.ft.com/4fCo6el

Let’s talk about the current economic climate and it’s effect on Commercial Real Estate: The market gets excited whenever there’s a hint that interest rates might drop, which makes people spend more and drives up prices. This can create a problem because then the people in charge might need to keep interest rates higher for longer to prevent prices from rising too much. It’s like a seesaw: when one side goes down, the other goes up. This can lead to problems like a weaker economy and trouble for banks, making it harder for people to borrow money. What risks does the commercial real estate sector face in an environment of prolonged higher interest rates? Firstly, higher borrowing costs can increase the financial burden on property owners and developers, potentially leading to reduced investment in new projects and slower growth in the sector. Secondly, rising interest rates may dampen demand for commercial properties as businesses face higher financing costs for expansion or relocation, resulting in decreased occupancy rates and lower rental income. Additionally, existing commercial real estate loans with variable interest rates may become more expensive to service, increasing the risk of default for borrowers and potentially leading to higher rates of loan delinquency and foreclosure. Overall, prolonged higher interest rates can weaken the profitability and stability of the commercial real estate market, posing challenges for investors, developers, and lenders alike.

Konrad Putzier of The Wall Street Journal writes about the flashing warning signs of the commercial real estate credit crunch: many office landlords cannot pay back their debt and are now struggling to secure new loans. This is due to a confluence of factors including high office vacancies, high interest rates, devaluation of real estate and banks seeking to limit their exposure to the challenged office sector. With more than $1.5 trillion of CRE loans due before the end of 2025, borrowers must be granted more time to restructure their debt with lenders to avoid more defaults and the far-reaching economic impact that will follow.

The NY Fed published this white paper “Extend-and-Pretend in the U.S. CRE Market”, which analyzes how banks have managed their exposure to distressed commercial real estate (CRE) loans in the post-pandemic period. Key findings include: 1) Extend-and-Pretend Behavior: Banks, particularly those with weaker capital positions, have extended the maturity of impaired CRE loans to avoid realizing losses, a practice known as “extend-and-pretend.” This has delayed the recognition of losses, preventing write-offs that could impact banks’ capital. 2) Impact on Credit Allocation: The study finds that this behavior has led to a decrease in new CRE loan originations, with an estimated drop of 4.8–5.3% since early 2022. This “credit misallocation” has hindered the adjustment of the CRE market to new post-pandemic realities, like shifts in office demand due to remote work. 3) Maturity Wall: The extensions have resulted in a “maturity wall,” where a significant volume of CRE loans is set to mature soon. As of late 2023, this volume is estimated to represent 27% of banks’ capital, posing risks if many loans default simultaneously. 4) Focus on Bank Capitalization: The analysis shows that undercapitalized banks, facing large unrealized losses from higher interest rates, were more likely to engage in extending maturities of distressed loans. This strategic behavior was aimed at maintaining regulatory capital levels despite rising risks in the CRE market. . . . . #nyfed #extendandpretend #cre #crefinance #maturity #gsp #axcspace #nyc

🌊Will the Wave of Maturities Sink Banks w/ a "Double Default" Tsunami?🌊 📉 Banks are staring down a new level of risk in the commercial real estate market — DOUBLE DEFAULTS. It turns out, the 'extend and pretend' strategy is concealing a growing systemic hazard. Here’s what’s at play: 1️⃣ The Double Default Threat: We’re seeing the highest number of borrowers in a decade who have defaulted again on modified loans. The re-default rate has surged, with $5.5 billion in re-defaulted commercial loans by the end of September. That’s up 90% over the last year. While banks may have delayed some write-offs, these re-defaults are a stark warning of what’s building up under the surface. 2️⃣ Extend and Pretend: To avoid immediate losses, banks have increasingly allowed borrowers to delay or modify payments — a quick fix to avoid outright write-downs. But with regulators starting to worry, and the New York Fed warning of “credit misallocation,” it's clear this could lead to severe financial fragility. 3️⃣ Office, Retail, and Multifamily at Risk: With office vacancies climbing and retail malls still struggling post-pandemic, defaults are rising in commercial real estate, even spilling over into multifamily properties. Interest rate hikes are keeping pressure high, meaning modifications are starting to look more like temporary band-aids than lasting solutions. 4️⃣ 2025 Maturity Wave Looms: A tidal wave of loan maturities is on the horizon, which could mean more defaults if interest rates stay elevated. Banks might have to increase reserves, impacting their balance sheets — all while vacant properties continue to pull down asset values. 🏢🏦 🛑 The Big Question: Will banks manage to ride out these double defaults, or is this just the start of a broader wave of losses? With $26 billion in delinquent loans and counting, it’s a significant concern for CRE, lenders, and the broader financial system. Let’s talk: do you think 'extend and pretend' will hold, or are we on the brink of an office market reset?👇 https://lnkd.in/grn8MVDg #CommercialRealEstate #DoubleDefaults #LoanLoss #BankingRisk #CRE #Loansales #Distresseddebt #nonperformingloans

Hugely important banking story in Financial Times showing that major banks are facing trouble in their loan loss provisions due to unanticipated high vacancy rates. This can be managed! Let's dive in. 🏦 New evidence shows that the biggest banks in the U.S. find themselves grappling with a surge in bad commercial real estate (CRE) loans. "The average reserves at JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs, and Morgan Stanley have fallen from $1.60 to 90 cents for every dollar of commercial real estate debt on which a borrower is at least 30 days late," according to new filings from the FDIC. 📈 A Surge in Delinquencies This downturn in reserves has unfolded over the past year, with delinquent commercial property debt for these six major banks nearly tripling to $9.3bn. The scenario is similarly grim across banks with the value of delinquent loans tied to offices, malls, apartments, and other commercial properties more than doubling last year to $24.3bn. “We have been closely focused on banks’ CRE lending,” said Michael Barr at the Federal Reserve. 🔍 The Reserve Dilemma Bank models of balance sheet risk have missed a major elephant in the room and failed to anticipate risk. “There are banks that may have looked fine six months ago, that are going to look not so good next quarter,” said Bill Moreland of BankRegData. Allowances for loan losses across the industry need substantial increases to address the growing risk. The reliance on historical loss rates for provisioning against CRE loans is now under huge scrutiny and banks have not adapted to CECL guidelines. "I know that the historical loss rates are low, but we need to see if the banks have been forward-looking in predicting expected losses, and not just relied on what has happened in the past," said João Granja, a coauthor at UChicago. 🏗️ Optimism Amidst Uncertainty Despite the concerning trends, some bank leaders remain confident in their institutions' resilience. Bank of America’s CEO, Brian Moynihan, in December pointed out the relatively small portion of their CRE debt tied to vulnerable market sectors, underscoring a sense of preparedness: "It’s such a small part of the table... We feel good." However, this optimism is tempered by caution. "Any downturn in provisions... would fundamentally be the wrong behaviour," said Richard Barkham, global chief economist at CBRE. Banks could face up to $60bn in losses from soured CRE loans in the next five years—roughly double what they've currently reserved for these losses. 📊 The coming months will likely reveal the full impact of the surge in CRE loan delinquencies and whether the banks' strategies will be sufficient to weather the potential storm. But rather than waiting for the storm, banks should bet ahead of the curve. This is exactly the modeling we do in Dainamic - see comments for a CECL whitepaper. #CommercialRealEstate #BankingCrisis #FinTech #RiskManagement #FinancialStability

https://lnkd.in/eHBrmtGm Last week, Federal Reserve Chairman Jerome Powell acknowledged that commercial real estate loan problems could cause "manageable" problems for "regional banks" for possibly "years." That reminds me of Former Fed Chairman, Ben Bernanke, saying the subprime loan problem was 'contained' in May 2007. Here's some context. The total size of the subprime loan market was $1.3 trillion at the time. Today's commercial real estate loan market exceeds $2.8 trillion. Last quarter's FDIC report notes the banking industry is showing "resilience" since the Silvergate, Silicon Valley, and First Republic Bank blow-ups. https://lnkd.in/e_vd33Wk Then there's the fine print. One chart shows that the industry's provision expense hit $24.7 billion in Q4 2023. That's the highest level since Q4 2020 aside from the two pandemic quarters in 2020. The FDIC attributes this to "higher credit card balances and charge-offs, greater risk in office properties, and increasing delinquency levels across loan portfolios." The problem is credit risk is growing on all those fronts. The US average office vacancy rate is 20%. Nearly 200 million square feet of office leases are expiring in 2024-2025. There are two possible outcomes: 1) At least 20% won't be renewed. 2) The rest will be renewed at lower prices. In addition, there are $1.4 trillion of CRE's maturing or in need of restructuring between now and 2027, with $270 billion this year and $560 billion by 2025. None of this bodes well for CRE loans. And that does not bode well for the regional or community banks holding 67% of them. We saw this play out in the 2007-2008 subprime debacle. The major disconnect between regulators and reality was the belief that these loans were sufficiently diversified to withstand system wide failure, and that the system wasn't leveraging them to the hilt. That was not the case then. It's not the case now.