(Bloomberg) — The U.S. commercial real estate market has been in turmoil since the start of the Covid-19 pandemic. But Community Bancorp of New York reminds us that some lenders are starting to see the pain.
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The bank's decisions to cut dividends and reserve balances sent its shares down a record 38% and dragged the KBW regional banking index to its worst day since the Silicon Valley bank's collapse last March. Japanese lender Azora Bank Ltd. warned of losses from investing in U.S. commercial real estate, sending shares down in Asia trade.
The concern reflects the ongoing decline in commercial property values and the difficulty of predicting which specific loans may be unwound. Setting that stage is a pandemic-induced shift to remote work and a rapid run in interest rates that have made refinancing more expensive for troubled borrowers. Billionaire investor Barry Sternlicht warned this week that the office market is headed for a loss of more than $1 trillion.
For lenders, the potential for higher defaults is higher as some landlords struggle to pay off loans or walk away from buildings.
“It's a big issue for the market to reckon with,” said Harold Portwin, principal at Keen-Summit Capital Partners LLC in New York, which specializes in refinancing distressed assets. “Banks' balance sheets don't account for the fact that there's a lot of real estate that's not going to pay off at maturity.”
Moody's Investors Service said it was reviewing whether to cut Community Bancorp of New York's credit rating to junk after Wednesday's developments.
Read more: NY Community Bancorp collapses as real estate risks jolt market
Banks face about $560 billion in commercial real estate maturities by the end of 2025, according to Trepp, more than half of all property loans coming due during that period. Regional lenders in particular are the hardest hit in the industry, and are hit harder than their larger peers by not having large credit card portfolios or investment banking businesses.
JPMorgan Chase & Co. released in April. According to the report, commercial real estate loans account for 28.7% of assets at smaller banks, compared to just 6.5% at larger lenders. That revelation prompted additional scrutiny from regulators, already on high alert following last year's regional banking turmoil.
Although real estate problems have become apparent nearly four years after the pandemic, the property market is in some ways in a slump: Uncertainty among both buyers and sellers about how much the buildings are worth has slowed transactions. Now, the need to address upcoming debt maturities — and the prospect of Federal Reserve interest rate cuts — is expected to prompt more deals that clarify just how much values have fallen.
Those slopes can be stark. The Aon Center, the third-tallest office tower in Los Angeles, recently sold for $147.8 million, a 45% reduction from its previous purchase price in 2014.
“Banks — community banks, regional banks — are very slow to mark things to market because they don't have to, they're holding them until they mature,” Portwin said. “They're playing with what these assets are really worth.”
Adding to the tension surrounding smaller lenders is the unpredictability of when and where real estate loans will occur, with a few defaults having the potential to wreak havoc. New York Community Bancorp said its fee increase was related to the co-op's building and office property.
While offices are a niche area for real estate investors, the company's biggest real estate exposure comes from multifamily buildings, with the bank owning about $37 billion in apartment loans. About half of those loans are backed by rent-regulated buildings, which are vulnerable to New York state regulations enacted in 2019 that strictly limit landlords' ability to raise rents.
Late last year, the Federal Deposit Insurance Corporation took a 39% discount when it sold about $15 billion in loans backed by rent-regulated buildings. In another sign of the challenges facing these buildings, New York City's rent-stabilized buildings with securitized loans defaulted at 4.9% as of December, triple the rate for other apartment buildings, according to a Treb analysis. was constructed.
Community Bancorp of New York, which bought part of Signature Bank last year, said Wednesday that 8.3% of its apartment loans were considered critical, meaning they were at high risk of default.
“NYCB was a very conservative lender compared to Signature Bank,” said David Aviram, principal of Maverick Real Estate Partners. “However, since loans secured by rent-stabilized multifamily properties make up a higher percentage of NYCB's CRE book compared to its peers, the change in the 2019 rental laws could have a more significant impact.”
Pressure is mounting on banks to reduce their exposure to commercial real estate. Although some banks held back large loan sales last year due to uncertainty, they are now expected to market more loans as the market thaws.
Canadian Imperial Bank of Commerce recently began marketing loans on struggling U.S. office properties. Although US office loans make up just 1% of their total asset portfolio, CIBC's earnings segment was dragged down by higher provisions for loan losses.
“The percentage of loans that banks have defaulted on is lower by the bucketload than the amount of loans that will occur throughout 2024 and 2025,” Aviram said. “Banks are exposed to these significant risks, and a potential decline in interest rates over the next year will not solve banking problems.”
–With assistance from Sally Bakewell.
(Updates with Azora Bank Real Estate Alert in second column)
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