Banks Selling Off Delinquent Mortgages
Banks are starting to sell off delinquent mortgages on expensive office buildings in many cities nationwide. Notably, Deutsche Bank, Goldman Sachs, and Canadian Imperial Bank of Commerce have recently sold loans on office buildings in New York City, San Francisco, Boston, and elsewhere. Despite the pattern, S&P Global Market Intelligence researcher Nathan Stovall said, “What you are seeing right now are one-offs” and that “banks are looking to shrink exposures.”
Extent of Commercial Loans in the Market
The commercial loans these banks sell are a small percentage of the total commercial real estate loans held by banks, which total $2.5 trillion across all U.S. banks. The commercial loans proving to be the most troubled are for large, urban, and expensive commercial properties with an abundance of traditional office space.
Supply and Demand Discrepancy
The discrepancy between supply and demand is due to the fact that the workforce most likely to want an office building space are knowledge workers, who are the least likely to return full-time to the office. Additionally, these properties are not easily or desirably convertible to other uses, such as residential units. There is no way to quickly make the office buildings more habitable for other purposes that would fit the needs of an urban center.
Changing Modes in the Banking Industry
The sale of troubled commercial mortgages indicates that the banking industry is changing modes. Specifically, the practice of “extend and pretend” has reached a limit, and banks are determining how to address the fact that the owners are likely to default on their astronomical mortgages. When mortgages default, banks and lenders are caught holding the expense, and bank earnings suffer.
Challenges with the “Extend and Pretend” Policy
The policy of “extend and pretend” has been the guiding principle for many lenders, who hoped that the trends would reverse and lessees could be secured to pay the mortgage balance for property owners who would then make good on their loans. However, extending the time and pretending that the fiscal equation will be realized financially has proven to be too optimistic to accord with the facts of today’s economy and the needs of business owners for office space.
Reluctance to Renegotiate Loans
During the “extend and pretend” era, banks and lenders have been reluctant to suggest that property owners renegotiate their loans due to the higher interest rate environment that exists now and will continue to some degree for the foreseeable future.
Impacts of Foreclosure
The extend-and-presume policy was as self-interested for the banks and lenders as it was helpful for the property owners, as a foreclosure and sale of the mortgage would have an adverse impact on the bank’s bottom line. For example, if a bank forecloses on a property, it loses real money, especially if it is forced to sell distressed properties at a discount. Some banks found it a better financial decision to sell and lose money under a controlled choice than be forced to sell at a catastrophically low discounted price in the future out of necessity.
Current Delinquency Rates
The most recent numbers reported by the banking industry show that under $37 billion in commercial real estate loans, equating to just over one percent of all bank loans, were delinquent. Delinquent status means that a mortgage payment is over 30 days overdue. This one percent figure is far less than the crisis in 2008 when the commercial real estate loan delinquency rates reached 10.5 percent.
Behind-the-Scenes Efforts by Banks
According to industry experts, banks are working behind the scenes to create attractive offers for investors to purchase delinquent loans. They are reaching out privately to potential buyers so as not to draw attention to the current fiscal crisis brewing in the commercial real estate market and spook bank and lender shareholders.
Regulatory Pressures
Regulators are also exerting pressure on the banks to reduce their exposure to commercial real estate loans in their portfolios. Smaller banks with less than $100 billion in assets, generally regional and community banks, hold up to two-thirds of all commercial real estate loans in the U.S., according to S&P Global Market Intelligence.
Vulnerability of Smaller Banks
A significant portion of these loans is held by community banks with less than $10 billion in assets. These banks are particularly vulnerable to a collapse, as they tend to be less diversified in their revenue streams than large banks. If they suffer a loss on a large mortgage, it could imperil the bank’s viability and that of their customers.
Upcoming Loan Due Dates
Madison Capital managing director Jonathan Nachmani has revealed that hundreds of billions of office building loans will be due within the next two years. He said that banks have not been willing to take the fiscal losses necessary to sell the loans in this environment where investors are not looking to add office buildings to their portfolios. Nachmani said, “Nobody wants to touch the office.”
Severity of the Problem
Michael Hamilton at real estate company O’Melveny & Meyers stated, “The general public does not have a sense of the severity of the problem. What I have been seeing is the cockroaches starting to come out.”
