Will coronavirus permanently change CRE lending?
The economic paralysis from the coronavirus outbreak could upend commercial real estate and accelerate loan losses for banks.
High vacancies are hurting hotels, while closed retail outlets are poised to cause headaches for malls and shopping centers. Offices could struggle over the long run as more Americans work remotely and employers decide they can get by with less space.
Those developments are apt to cause near-term credit issues and long-term adjustments in the CRE business.
“There could be a lot of pain,” said Matthew Anderson, a managing director at the data firm Trepp.
A recent Trepp analysis of 12,500 CRE loans held by U.S. banks determined that industry loss rates could jump from less than 1% in 2019 to 2.5% five years from now. Anderson said the bulk of that hit would come this year and in 2021.
The hotel industry faces the grimmest outlook. Trepp estimated a 35% default rate and a 13% expected loss.
The biggest concerns focus on declining rents and rising vacancies, which would crimp property owners’ revenue and their ability to pay their loans, Anderson said. Multifamily apartment buildings and industrial properties should fare better, Trepp found, though their loss rates will also rise substantially.
“There are still a lot of unknowns, and hopefully this is a short-term event, but even in the near term we’re going to see some relatively awful numbers,” Anderson said.
The “extremely adverse” scenario that the Federal Reserve included in its annual stress testing, which includes unemployment more than tripling and asset prices cratering, was the foundation for Trepp’s analysis.
Trepp factored in the known impacts of the coronavirus pandemic to date to enhance the worst-case scenario, layering in a 35% plunge in CRE prices over the first two years. Falling prices would make it harder for property owners to refinance as loans mature.
Industry observers anticipate severe credit quality challenges and mounting charge-offs.
The U.S. almost certainly will descend into a substantial recession in the second quarter, said Stephen Scouten, an analyst at Piper Sandler. While banks, in general, are well capitalized and capable of absorbing near-term loan losses, Scouten said the pandemic could overwhelm some lenders if the economy struggles beyond this year.
“Do charge-offs increase for one quarter or six quarters?” Scouten said. “That’s a very big question right now.”
Given the severity of coronavirus outbreaks so far, industry experts said they expect large markets in states such as California, New York and Washington to present the greatest initial challenges.
The immediate economic damage inflicted by the pandemic will “amount to a bloodbath” in the second quarter in terms of gross domestic product, said Kevin Cummings, chairman and CEO of the $26.7 billion-asset Investors Bancorp. The Short Hills, N.J., company is a prominent retail and hotel lender in the New York area.
“We’re looking at everything very closely,” he said.
Cummings, however, said he is optimistic that emergency federal government action — notably the $2 trillion stimulus package passed last week that included hundreds of billions of dollars in low-cost loans and other aid for businesses — will blunt the impact and help the economy recover later this year.
“I’m not downplaying this — it’s unprecedented what we’re experiencing as a country,” Cummings said. “But it’s time to step up, and we’re going to see aggressive public-private partnerships to get us through this.”
Cummings said that, unlike in the 2008 financial crisis, when banks were blamed for the recession, lenders entered this year with plenty of capital and a relatively positive relationship with regulators and lawmakers.
Regulatory restrictions are also easing to help banks provide immediate relief to affected clients.
The agencies “have told banks — in no uncertain terms — that they are to work with impacted borrowers,” the research team at D.A. Davidson wrote in a note to clients. That assistance includes forbearance, fee waivers and delays on foreclosures.
While banks are equipped to handle near-term challenges, they must be prepared for longer-term changes to commercial real estate, industry observers said.
One possibility is a systemic decline in demand for office space.
With millions of Americans working remotely for the first time, many employers are learning to manage a dispersed workforce and how to cut costs from doing so, said Lynn David, president of Community Bank Consulting Services in St. Louis.
Increased telecommuting should take hold after this crisis, David said, as more companies calculate how the practice can lower costs tied to office space, utilities and parking.
Decreased demand would increase vacancy, pressure rents, clog landlords’ cash flow and, ultimately, their ability to pay their loans.
“That would cause significant credit problems for some banks,” David said.
To be sure, more time and data is needed before predicting the fate of lending, including CRE.
It is too soon to forecast how the pandemic will affect loan portfolios, said David Nasca, president and CEO of the $1.5 billion-asset Evans Bancorp in Hamburg, N.Y. Still, he said, many banks are looking closely at boosting first-quarter loan reserves while remaining on the lookout for early evidence of long-term issues.
“We’re so early in this battle that’s it tough to get a handle on this,” though economic warnings signs are “flashing red right now,” Nasca added.
Allissa Kline contributed to this article.