The stress seen in the commercial real estate sector right now is weighing heavily on banks and regulators alike, and it’s regional banks that are the most vulnerable. A Bank of America report shows that 68 percent of commercial real estate loans are currently held by regional banks. Moreover, estimates by JPModrgan Chase indicate that these types of loans account for an average 28.7 percent of regional and smaller banks’ assets and that 21 percent of commercial real estate loans are likely to default, which could cost banks roughly $38 billion in losses.
Commercial mortgages are currently facing multiple threats. Rising interest rates are making it costlier for borrowers to refinance, while dwindling demand for office space as more people work remotely is causing credit concerns for landlords.
The commercial real estate loans that originated ten years ago and are now coming due could put borrowers in a very unfavorable position. The average mortgage rates when these loans originated were 4.58 percent; they are now around 6.5 percent.
Debt service coverage ratios are a major factor considered by banks when deciding whether to extend a commercial real estate loan, and it is projected that anywhere from 28 to 44 percent of currently outstanding loans of this type would not meet the 1.25 debt service coverage ratio required today and would therefore not be eligible to refinance.
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Moreover, these calculations were performed on the assumption that current cash flows on the properties involved remain the same, but many landlords have less cash flow these days in the wake of rising vacancies. On top of that, banks are largely switching to amortizing mortgages rather than the interest-only loans favored in the past, which would push debt service payments even higher.
American Institute for Economic Research Economist Peter Earle told the Epoch Times: “It’s a very different world now from the one in which the majority of these loans were made.
“In a zero-interest-rate environment, before the COVID lockdowns saw many businesses shift to a remote work basis, many of these loan portfolios full of office properties looked great. Now, a substantial portion of them look quite vulnerable.”
Some areas are being particularly hard hit. For example, New York City saw its office occupancy rates fall dramatically from 90 percent to 10 percent during the pandemic in 2020; they have only recovered to 48 percent so far. In Los Angeles, office vacancies have risen to a record-setting 22 percent, while San Francisco office sublease offers have climbed by 140 percent since 2020.
Delinquencies on commercial mortgage loans are already rising, with missed payments on commercial mortgage-backed securities jumping half a percent in May over April to hit 3.62 percent. The problem was particularly pronounced in offices.
At the same time, the values of commercial properties, which serve as collateral for these loans, are also taking a hit.
Many banks are already trying to sell off their portfolios
After the collapse of banks like Silicon Valley Bank and Signature Bank, many regional banks are trying to sell off their commercial real estate loans, even if they have to do it at a loss, in hopes of avoiding a similar fate.
Wells Fargo announced it would be downsizing its CRE portfolio and taking losses, while PacWest sold $2.6 billion in construction loans at a loss last month. Citizens Bank has put $1.8 billion worth of CRE loans for sale in recent months, while Customers Bancorp has placed $16 million of its current CRE portfolio for sale.
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