(Bloomberg) — The decline in office property values is sweeping through U.S. banks, and smaller lenders in particular are increasing their use of loan modifications on their commercial real estate books.
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The typical bank with less than $100 billion in assets modified 0.32% of its CRE loans in the first nine months of the year, according to a report from Moody’s Ratings. This is a large increase compared to the first half of 2024, when it was just 0.1%.
But it is also a much lower percentage than what other types of lenders have changed: for medium-sized banks, the share was 1.93% in the first nine months, and for the largest, it is 0.79%, according to the report. The difference is probably not because smaller lenders have made better loans, but rather because they have been slower to deal with falling commercial property prices.
Modifications are often sought by distressed homeowners looking to postpone payments and obtain short-term extensions on loans. Its increased use is the latest sign of growing difficulties in CRE credit as a wave of loans must be refinanced.
Much of the focus is on regional banks, which are especially vulnerable because they often accepted lower down payments than their larger counterparts in the years before interest rate hikes that began in 2022. That means they have less margin of protection before taking action. Losses after office and apartment complex values fell at least 20% from the peak.
At the same time, large American lenders, which are subject to stress tests and other forms of intense regulatory scrutiny, have so far been setting aside more money to cover bad loans than smaller banks, according to Rebel Cole, a finance professor in Florida. . Atlantic University, which also advises Oaktree Capital Management LP.
Concerns about future losses have contributed to the underperformance of smaller banks’ share prices, with the KBW regional banking index gaining about 17% this year compared to about 30% for the KBW Nasdaq global banking index.
About $500 billion in CRE mortgages will mature next year “and a significant portion of them will go into default,” said Cole of Florida Atlantic University. “There will be liquidation sales. “They are going to put more downward pressure on commercial real estate prices across the board.”
Federal Deposit Insurance Corporation Chairman Martin Gruenberg warned Thursday that weaknesses in some banking system loan portfolios, including office and multifamily, continue to warrant close monitoring.
Office loans will plague public mortgage REITs and the vast majority of banks for a long time, Mike Comparato, president of Franklin BSP Realty Trust Inc., told analysts last month. Those assets are trading “at levels that were simply unfathomable.” a few years ago. “We are also hearing anecdotes of lenders being unwilling to take ownership of office assets to avoid the realities of market value.”
Compounding lenders’ pain, this year’s interest rate cuts by the Federal Reserve have failed to reduce long-term borrowing costs. That makes it more difficult for landlords to refinance their debt to a level that can be covered by rental income.
“There’s starting to be some capitulation,” said Robin Potts, chief investment officer of the real estate unit of special situations investor Canyon Partners LLC. “Borrowers who miss payments cannot extend their term forever.”
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