Commercial real estate loan delinquencies among U.S. banks continue to pile up as the nation sees fallout from a post-pandemic office market.
The delinquency ratio for CRE loans across banks rose 16 basis points in the second quarter, to 1.4%, according to data from S&P Global Market Intelligence. It’s the seventh consecutive quarterly increase for that metric. To deal with rising vacancy and plummeting values of office buildings — leading to the uptick in delinquent or distressed loans — more banks with large office portfolios have been lifting loss reserves incrementally.
Also because of the stress in commercial real estate right now, banks continue to pull back on new issuance to the sector. Year-over-year CRE loan growth across U.S. banks slowed to 2.2% in the second quarter, compared to 2.9% the prior quarter and down substantially from a recent peak of 12.1% in the third quarter of 2022.
Many lenders, banks included, have thus far largely opted to issue short-term extensions on maturing loans backing commercial real estate properties, or are adjusting loan terms at refinancing.
“The catalyst that would really force the issue here is the maturity wall, when these loans mature,” said Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence. He added S&P is estimating 2027 to be the peak year for CRE loan maturities, with nearly $1.26 trillion expected to come due that year. An estimated $950 billion in commercial real estate mortgages is expected to mature this year.
Although federal regulators are concerned about banks with elevated exposure to commercial real estate, so far they’re largely still allowing those institutions to extend loans and give borrowers more time, Stovall said.
It’s likely there will be more merger-and-acquisition activity among banks with heightened exposure to commercial real estate, with one example being Bank of America Corp. (NYSE: BAC) agreeing in May to purchase a portfolio of Washington Federal Bank’s (Nasdaq: WAFD) multifamily properties for $2.9 billion.
M&A deals overall have been slow, but it’s likely activity will start picking up in 2025 depending on the economy’s trajectory, Stovall said.
At the same time, the number of banks exceeding a threshold regulators set in 2006 for CRE loan exposure is dwindling. Regulators set that threshold to include banks in which CRE loans represent more than 300% of risk-based capital and 36-month CRE loan growth of 50% or more, or construction and development loans that are at least 100% of a bank’s risk-based capital.
The number of banks exceeding that regulatory guidance in Q2 fell for the fifth consecutive quarter, to 482. The number of banks that exceeded the criteria hit a recent peak in Q1 2023, at 577. Although unrelated to U.S. commercial real estate fallout, that happened to be the same quarter as the failures of Silicon Valley Bank and Signature Bank.
“After that happens, it’s all hands on deck in the regulatory community,” Stovall said, adding attention has since turned to banks with significant office-market exposure. “We have changes in the way people work. You’ve seen net outmigration from certain cities. It’s location location location when it comes to real estate. I think, ultimately, [regulators] have the tools in the toolbox, but they’re pushing harder on those tools.”
Amid recent M&A activity, some banks have upped their exposure to commercial real estate, putting them on the radar of regulators. Provident Financial Services Inc., for example, newly exceeded CRE loan-exposure guidance in the second quarter after it purchased Lakeland Bancorp Inc. Regulators approved the deal with a number of conditions, including a $200 million capital raise.
“That gives you an idea that they’re getting more aggressive,” Stovall continued.
Among the 20 banks with the largest CRE portfolios, such loans fell by a median 2.1% year over year as of Q2, with a dozen of them posting declines.
Although more banks are on regulators’ radar because of the fallout in commercial real estate, there are still a number of factors that will help insulate the financial system from a more crippling effect, Stovall said. For example, underwriting standards heading into the pandemic were much stricter than they were ahead of the Global Financial Crisis, and more equity was required in deals. And even though fallout in commercial real estate is widely expected to be a long-term storyline, delinquencies today are still a fraction of what they were during the 2008 downturn, Stovall said.
“Those are all good things,” he said. “There’s this huge private-equity market chasing after real estate assets. It’s going to be put to work. There might be alternatives [to banks]. It doesn’t erase any problems here but it puts a floor on it from where it would be otherwise.”
Interest-rate outlook
All eyes are on the Federal Reserve, which is widely expected to issue its first interest-rate cut later this month amid a cooling labor market and reduced inflation.
While rate cuts are seen as a way to unlock more liquidity in the market, including commercial real estate, one or two rate cuts aren’t likely to make a huge difference ultimately in the challenges facing the sector.
The average interest rate on CRE loans that originated this year is 6.2%, compared to an average 4.3% on mortgages about to mature. That’s nearly a 200 basis point difference, a gap that won’t be covered by a couple of rate cuts, Stovall said.
“This thing takes longer than I think a lot of people thought six or nine months ago,” he said. “Rate cuts help, but I don’t think it honestly changes the story. [And] if rates fall 200 or 300 basis points in the short term, the Fed is seeing something really bad [in the economy].”
Source: “Commercial real estate loan delinquencies see uptick among banks”
