Wave of commercial loan maturities and distressed property sales threaten smaller banks
The sharp decline in office property values is exposing vulnerabilities in US regional banks, with many ramping up loan modifications to manage growing distress in their commercial real estate (CRE) portfolios.
Banks with less than $100 billion in assets modified 0.32% of their CRE loans in the first nine months of 2024, up from 0.1% in the first half of the year, according to a Moody’s Ratings report. However, smaller banks still trail medium-sized institutions (1.93%) and larger lenders (0.79%) in confronting declining commercial property prices.
The difference, Moody’s suggested, may be because smaller banks may be slower to confront the reality of falling commercial property prices. These modifications often provide short-term relief for landlords unable to meet payment obligations by extending loan terms.
Regional banks are particularly vulnerable due to their lenient lending practices in prior years. Lower down payments left them with thinner buffers against the sharp 20% decline in office and apartment complex values since their peak.
With roughly $500 billion in CRE mortgages set to mature in the next year, experts anticipate a wave of defaults, forcing distressed sales that could push property values even lower.
“There are going to be fire sales,” said Rebel Cole, a finance professor at Florida Atlantic University. “They’re going to put more downward pressure on commercial real estate prices across the board.”
These concerns have taken a toll on smaller banks’ stock performance. The KBW Regional Banking Index has gained about 17% this year, compared to a 30% increase for the KBW Nasdaq Global Bank Index, which tracks larger banks.
Regulatory scrutiny intensifies
Federal Deposit Insurance Corporation (FDIC) chairman Martin Gruenberg has flagged office and multifamily loans as areas of concern, urging banks to monitor these loan portfolios closely.
Larger banks, which are subject to stricter regulatory oversight, have been more proactive in setting aside reserves for potential losses, providing a contrast to smaller lenders.
Mike Comparato, president of Franklin BSP Realty Trust Inc., cautioned that office loans will remain a problem for both mortgage real estate investment trusts (REITs) and banks for the foreseeable future.
“Office assets are trading at levels that were simply unfathomable a few years ago,” he said, noting a reluctance among some lenders to take ownership of distressed properties to avoid marking them to market.
Rising refinancing challenges
Compounding the strain, this year’s Federal Reserve interest rate cuts have not translated into lower long-term borrowing costs, further complicating refinancing efforts. This makes it harder for landlords to refinance their loans at levels sustainable with current rental income, leading to a rising number of defaults and loan extensions.
Read next: CMBS delinquencies rise again as office loans face growing distress
Robin Potts, chief investment officer at Canyon Partners’ real estate division, said this situation is forcing some landlords to “capitulate.”
“There’s starting to be some capitulation,” Potts said. “Borrowers who aren’t making payments can’t extend forever.”
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