Banks Are Purging Bad CRE Debt From The Good Old Days
Two years after the failures of Silicon Valley Bank and Signature Bank touched off waves of panic over the concentration of commercial real estate loans held by regional banks, financial institutions are making a dent in their balance of bad debt.
Concerns about regional banks' ability to absorb declining real estate values became pervasive despite a pullback from CRE lending in the wake of the banks’ failures.
Banks are weathering the downside of the cycle and are moving old debt off their books, new Trepp data suggests. The financial institutions are, at least for now, avoiding the widespread distress that analysts saw forming in early 2024.
“We're going through somewhat of a purgatory process right now for those loans that were originated at the height of market exuberance — call it the zero-interest-rate phenomenon,” said Tom Taylor, senior manager of research at Trepp. “Charge-off rates will likely increase, my guess is in the office property type, and I don’t suspect that many others will increase.”
Delinquencies for bank-owned commercial real estate debt ticked down modestly in the fourth quarter to 1.99%, the first decline since 2022, which came even as CMBS delinquencies climbed to 6.57%.
But net charge-offs ticked up 20 basis points, dominated by $1B worth of write-downs on office debt from banks that don’t show up in delinquency rates. The number of criticized loans, or debt that has been flagged internally as having a higher risk profile, is also rising.
New loan origination, which dried up amid increased regulatory scrutiny and rising interest rates, remains anemic compared to prepandemic levels.
From 2020 to 2022, when the Federal Reserve’s benchmark rate was zero percent, tremendous amounts of capital flowed out of banks to finance new projects and acquisitions. In the first half of 2022, banks provided $316B in net new commercial real estate loans, 172% higher than the same period a year prior.
Then the Fed began to raise rates, and banks largely disappeared from the scene, replaced by private credit.
The falloff of new loans when the Fed began to increase rates is also helping keep bank loan delinquency rates lower today, Taylor said.
“Enough banks basically hit the brakes on their originations and underwriting standards,” he said. “That concern in the originations has led to an off-the-top decrease in delinquency.”
New loan origination was at $5.6B in the fourth quarter, marking the third consecutive quarterly increase, but still 41% of the average prepandemic volume. The bank loan data comes from the Trepp Anonymized Loan Level Repository, which consists of a network of participating banks and captures an average of $7B in quarterly originations.
Loans with shorter terms that were underwritten as the Fed began tightening monetary policy are the most likely to be facing repayment or refinancing issues today, Taylor said. And something of a threshold is forming around a 1.5 debt service coverage ratio to determine whether a property is going to trade for a loss.
“Because banks underwrite to very strict standards, even before the pullback occurred, very rarely do their loans approach that metric,” he said. “Even going forward, it's really going to be edge cases.”
The debt moving off of banks’ portfolios is largely long-term refinancing deals, as opposed to the short-term extensions that had become a common strategy when investors expected borrowing costs would come down faster than they have. Conversations about loan extensions also start with questions about how much new capital the owner is bringing in, Taylor said.
“Lenders are definitely willing to work with borrowers, but they're requiring borrowers to come to the table with some sort of additional skin in the game,” he said.
