With commercial real estate set for another tough year, some small banks are worried
With commercial real estate set for another tough year, some small banks are worried
Things haven’t been easy for the commercial real estate sector over the last few years. Recently, a lot of companies have been downsizing their office footprint and letting go of bigger leases. At the same time, building owners are facing higher interest rates on loans.
Those pressures aren’t only problematic for the owners of office buildings and other types of commercial real estate. They’re also worrying lenders that have a lot of CRE debt on their balance sheets.
Commercial real estate loans don’t work exactly like mortgages, whose interest rates can usually be locked in for 30 years by borrowers. Commercial loans have to be renewed at new interest rates, in many cases every five years or so.
“And a lot of the loans that are on the books today were written, or made, when rates were … superlow,” said Dominik Mjartan, CEO of Optus Bank in South Carolina.
Many of Mjartan’s commercial real estate loans will be up for renewal in the next year or two. In fact, a record amount of CRE debt will mature this year, according to an estimate from the real estate data company Trepp.
“That’s the scary thing — that bubble is coming,” Mjartan said.
It’s scary, Mjartan added, because borrowers might not be able to afford their payments at today’s higher interest rates. In the worst-case scenario, a bank might have to foreclose. That’s not something lenders want to do.
“It just really eats you up alive because it’s destructive,” Mjartan said. “That process destroys the value in the community, and it really sabotages the chances that that borrower, the customer who you want to help, will recover.”
So Mjartan said he and lenders like him will be doing everything in their power to avoid foreclosures. For instance, lenders and borrowers can tweak loans so they have more favorable terms. But Mjartan said there are limits to how much banks can do.
“If you’re not doing it on market-rate terms, your auditors, and your loan review, and your examiners, when they come to look at your portfolio, they’re going to look at it really closely and see if you’re essentially hiding troubled debt,” Mjartan said.
Last month, the Federal Deposit Insurance Corp. reminded banks to keep a tight rein on how they manage risk and keep a close eye on their borrowers’ property values.
A big concern is whether banks can absorb the blow if some loans go bad, said Columbia Law professor Kathryn Judge.
The Federal Reserve said delinquencies on commercial real estate loans have been rising over the last year. And regulators are worried about what will happen if those delinquencies start turning into defaults, Judge said.
“Then, you’re in a situation where you have some banks that did a lot of lending into commercial real estate, and those are likely to be small banks and some of the regional banks, where suddenly numerous loans in their portfolio are defaulting at the same time,” Judge said.
Some lenders don’t have to worry about the weakest parts of the commercial real estate sector.
“To be honest, I don’t have any big office tower loans in my area,” said Brad Bolton, CEO of Community Spirit Bank, which serves customers in northwest Alabama and northeast Mississippi. “They just don’t exist.”
Bolton said his bank’s commercial real estate loans were made mostly to local businesses — grocery stores, hardware stores, health care clinics — and those are doing OK.
“Our economy’s been pretty strong,” he said. “Unemployment is still very low in the four counties that I primarily serve.”
Still, Bolton admitted his bank is being more diligent about ensuring that borrowers can handle higher rates.
Nathan Rogge, the CEO of First Pacific Bank in Southern California, has been running a lot of stress tests on his borrowers, looking at what happens if interest rates and vacancies rise even more.
“You assume certain vacancies,” Rogge said. “If you underwrote an office building and it was 95% occupied, what happens when it’s 50% occupied?”
Rogge said he’s also been rethinking the types of new commercial real estate he’s willing to lend for.
“I’m not going to be too excited to get into office space for new lending versus something else, like manufacturing, lab space or something like that,” Rogge said.
That’s because those kinds of properties, he added, aren’t suffering the same downturn that office space is.
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