CRE concerns intensify as stimulus programs expire

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Uncertainty about exposure to commercial real estate continues to dog banks.

While many lenders have reported a steady decline in loan deferrals, industry observers are concerned about future demand for retail and office space and what would happen if legislators fail to approve more stimulus for existing tenants. And a number of CRE borrowers are barred from participating in federal pandemic-relief initiatives like the Main Street Lending Program.

The overall CRE delinquency rate for banks increased to 0.92% on June 30 from 0.83% a quarter earlier and 0.68% at the end of last year, according to Federal Reserve data. While much lower than levels seen during the financial crisis, it is the highest rate since early 2016, and some industry observers fear it will continue to climb in coming quarters.

As stimulus programs expire, more tenants will likely miss rent payments, putting more pressure on commercial landlords trying to pay their mortgages.

“What happens when all this stimulus goes away, when these deferral periods end?” said Jon Winick, CEO of Clark Street Capital. “I think we’re going to see many more challenges. The credit picture right now is a mirage.”

“It is sobering to think about what things could look like for banks without any more stimulus,” said Matthew Anderson, a managing director at Trepp.

And there are signs some borrowers are purposefully defaulting after realizing they would be unable to extend or refinance their loans — a development that could hasten a wave of foreclosures later this year.

Loans set to mature over the next five quarters have delinquency rates that are materially higher than other loans, Trepp researchers said in a recent report. Within that group, delinquency rates for loans with balances greater than $25 million are significantly higher than those for smaller loans.

“Larger borrowers are typically more sophisticated and less likely to be encumbered by recourse or guarantees, making strategic default a more rational decision,” Trepp’s researchers said.

High vacancies are crippling many hotels and reduced foot traffic is hurting retailers in malls and shopping centers. Office buildings are another potential source of weakness as more Americans work remotely and more employers consider reducing their physical space.

“Those areas continue to be under the most pressure,” Anderson said. “The numbers now are not as dramatic as feared, but because of the various stimulus, they are understated.”

Lawmakers are also concerned.

At a hearing of the House Financial Services Committee on Tuesday, members pressed Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin to allow CRE borrowers to access government relief programs.

Deloitte has forecast that charge-offs for loans secured by office, retail, industrial and hotel properties could rise to 0.47% of the outstanding balances for those credits. While well below the 1.65% mark reached in 2010, it would mark a surge from just 0.05% before the pandemic.

While some markets and industries recovered over the summer, sectors that were struggling pre-pandemic face steepening challenges.

Deloitte noted in a recent report that 90% of the newly distressed assets in the second quarter were tied to the hotel and retail industries. Retail developers are dealing with the added challenge tied to consumers’ shifting preference for digital commerce.

While a number of bankers have said that the overall economy seems to be slowly healing and that most borrowers are making loan payments, a lot of uncertainty still exists.

“There are still a lot of unknowns,” said Brian Martin, an analyst at Janney Montgomery Scott.

Deferral rates, though down, remain historically high, averaging 7% of total loans at banks covered by Janney. The credit picture could darken notably if a meaningful chunk of those loans become delinquent, Martin said.

“We may not really figure out where things stand until the fourth quarter or even next year,” Winick said. “But anyone who would claim victory now, in terms of credit quality, would be highly misleading.”

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Commercial real estate lending Credit quality Main Street Lending Program Coronavirus
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