Bad debt on bank balance sheets ticked down again in 2022, but the data belies a wave of loans maturing this year that could translate to distressed offerings for equity buyers.
Just $10.4 billion of commercial, multifamily and construction/land loans held by the top 300 banks were nonperforming at yearend, according to Trepp Bank Navigator. That’s 0.5% of total loan holdings, down slightly from 0.6% in 2021, when nonperforming debt totaled $11.9 billion. The top 300 banks had only $1.1 billion of foreclosed properties on their books at yearend, down nearly 17% from $1.3 billion the year before.
As a share of overall holdings, nonperforming loans haven’t accounted for 1% of bank loans since 2015, but market pros say that’s about to change.
Trepp estimates that about $80 billion of bank office loans will come due this year. “Those are all loans that if the lender could step away from … they would love to,” Trepp managing director Matt Anderson said. “The current lenders are faced with needing to either refinance those loans or look at those as heading to default and taking a loss on it.”
Anderson noted that some of those loans will have suffered occupancy and/or income loss, “so even if the lender comes back in with a stapled loan to help keep it afloat, it’s going to be on lower terms, so there’s probably going to be some losses there regardless.”
He added that while bank balance sheets looked strong at yearend, nonperforming loans are a lagging indicator. “It takes a while for actual problems … to then show up in the delinquencies and defaults,” he said. “Then it takes another little while for that to flow into nonperforming loans and foreclosures and REO.”
Opportunistic buyers already are disappointed at the lack of distressed debt being shopped by bankers and borrowers.
Potential trades are being thwarted by a wide bid-ask spread, said Raymond Chalme, chief executive of Broad Street Development who recently launched Paradigm Advisory Group to work with lenders, servicers and property owners dealing with distressed office and apartment properties in New York. That gap “has to move to kind of establish the next layer of watermark,” he said.
“A lot of the equity is probably out of the money,” he added. “A lot of [preferred equity] and [mezzanine financing] is somewhere out of the money, and we’re trying to see where that is.”
Nick Seidenberg, a managing director and loan-sales specialist at Eastdil Secured, said that headlines about commercial real estate are overstating the risk in the market. While office buildings are facing a secular shift in usage and value, the industrial, multifamily and retail sectors remain strong, as do niche property types like student and senior housing and data centers.
“The real distress is on the office side,” he said. “The main difference in office versus all these other asset classes is the retenanting cost and the cost to stabilize is so significant.”
While staggered maturities and in-place leases may delay trouble for some office properties, chances to buy those buildings at discounts eventually will emerge, Seidenberg said.
He said that, since January, Eastdil has provided lenders broker opinions of value on roughly $16 billion of properties, 80% of which were office properties. “So that’s where the activity will be from, whether loan sales or short sales,” Seidenberg said. “There’s going to be a lot of opportunity for buyers to buy office buildings at a reset basis.”
Trepp’s Anderson said that how much distress eventually emerges will be proportional to how hard a line banks take with their borrowers.
“We all learned a strange lesson from the [global] financial crisis, which was that extend and pretend seemed to work,” he said. “So for the banking industry broadly and all sorts of individual players, when they really rolled up their sleeves and made as many accommodations as they could to keep loans and borrowers afloat, that worked out.”
Seidenberg questions whether banks and other lenders will provide extensions and forbearances for office properties facing existential questions of value, especially without extracting material concessions from borrowers.
“From the bank side, because of the regulation, I don’t think they’re just going to be given the ability to kick the can,” he said. “They need something from the borrower to get extensions, whether that’s a partial paydown, escrowing money for interest reserves and [tenant improvements/leasing costs]. The borrower needs to give them something.”
Jack Howard, an executive vice president and a senior partner in CBRE’s national loan and portfolio-sale advisory group, said extensions and modifications are most useful when borrowers are willing to put new capital into a property.
“In some asset classes, that’s going to make more sense than others,” he said. “With office, there’s a supply-demandimbalance. … Loan [modifications] will only work when you’ve got both sides willing to do that, and some sponsors are not willing to commit new capital to office product.”
Patrick Arangio, a vice chair in CBRE’s national loan and portfolio-sale advisory group, said much of what will happen remains tied to the Federal Reserve’s policy on interest rates.
“So much of what is driving decisions — both on the lender and sponsor sides — is predicated
on where rates settle,” he said. “If the market anticipates a dovish tilt in policy, then you may see groups choose to wait to make decisions. If the Fed remains hawkish, we think this will drive increases in loan
sales in the near term.”
Howard noted that banks also may write down commercial real estate loan values over several quarters, further delaying opportunities for distressed buyers. “Banks have historically been prudent with regards to making sure they’re provisioned correctly prior to incurring losses associated with nonperforming office loan sales,” he said. “We expect they’ll continue to take write downs in anticipation of increased disposition volumes.”
That said, Arangio believes that both owners and lenders have been “actively triaging their books for the better part of 24 months.
“I don’t think anyone is saying ‘office bad, multi good,’ ” he said. “It’s more that ‘we know what we have, we’ve been studying it for three years … we know which assets we are going to protect. At some point, we’ll have to decide where to focus our dollars going forward, especially if an asset has significant near-term capital requirements.’ ”
Some good news for lenders is that the field of players eyeing distressed opportunities remains crowded, meaning demand for troubled plays is high. By nearly every metric, a record amount of dry powder is targeting commercial real estate, and much of that is seeking higher returns from opportunistic investments.
“What we saw in the [global financial crisis], and in a smaller way during Covid, is that there is a lot of money out there that you can line up for making opportunistic bets,” Trepp’s Anderson said. He noted that during the real estate recession of the early 1990s, there was zero liquidity for years, but in the Great Recession, the period of no liquidity lasted only about six to eight months, which meant property prices didn’t fall as far as they might have.
“For marginally distressed real estate, there might be a middle path,” Anderson said. “[Banks will] sell at a discount, of course, but maybe not the huge discount that opportunistic buyers would be hoping to get. There might be some loss for the lender, but maybe not as massive as they might have been looking at.”
For the second year in a row, M&T Bank held the most distressed debt, with $1.6 billion of nonperforming loans, up 37% year over year from $1.2 billion. Prior to the last two years, Wells Fargo had held the top spot each year since Trepp began publishing bank data in 2010.
M&T’s rise in distressed holdings follows its purchase of People’s United Bank, which closed in April 2022. Anderson noted that when banks merge, the resulting entity typically designates a larger amount of debt as distressed for accounting purposes.
Wells repeated in second place, with $836 million of nonperforming loans, down 16% from the prior year. Goldman Sachs ($671 million of nonperforming loans, up 29% from $521 million), JPMorgan Chase ($592 million, down 9% from $651 million) and Capital One ($470 million, down 4% from $488 million) rounded out the top five.
Trepp Bank Navigator data is based on reporting by U.S. banks, including those that have foreign ownership, but excludes the holdings of foreign banks’ U.S. branches and agencies, which are reported separately.