Wall Street Banks Begin Offloading Commercial Real Estate Loans Amid Market Distress

Wall Street Banks Begin Offloading Commercial Real Estate Loans Amid Market Distress

Edited by: TJVNews.com

In response to growing concerns over the ability of landlords to repay mortgages on vacant and struggling office buildings, some major Wall Street banks have started offloading their portfolios of commercial real estate loans, according to a report that appeared on Monday in The New York Times. This move, though early, is a significant indicator of the broader distress that is brewing within the commercial real estate market.

The commercial real estate market is currently grappling with the dual challenges of high interest rates and low occupancy rates for office buildings. As was explained in the NYT report, high interest rates make refinancing loans more difficult and expensive, while low occupancy rates, a lingering consequence of the COVID-19 pandemic, continue to depress rental incomes and property values.

Several high-profile transactions have highlighted this trend. Late last year, an affiliate of Deutsche Bank and another German lender sold the delinquent mortgage on the Argonaut, a historic 115-year-old office complex in Midtown Manhattan, to the family office of billionaire investor George Soros, according to the information provided in The Post report. Around the same time, Goldman Sachs sold loans tied to a portfolio of troubled office buildings located in major cities such as New York, San Francisco, and Boston, the NYT report indicated. In May, Canadian lender CIBC completed the sale of $300 million worth of mortgages on a collection of office buildings nationwide.

In April, Soros’s family office moved to foreclose on a delinquent loan it had acquired from Deutsche Bank and Aareal Bank, a smaller German bank with an office in New York. The NYT reported that according to court papers filed in Manhattan Supreme Court, this foreclosure action calls attention to the financial struggles facing commercial real estate properties. Interestingly, one of the tenants of the Argonaut building is Soros’s own charitable organization, the Open Society Foundations, the NYT report pointed out. Despite the high-profile nature of this case, a spokesman for Soros declined to comment to the NYT on the proceedings.

According to Nathan Stovall, director of financial institutions research for S&P Global Market Intelligence, these sales, while currently isolated incidents, are part of a broader trend. Stovall notes that banks are increasingly looking to reduce their exposure to commercial real estate. “What you are seeing right now are one-offs,” he told the NYT. He added, “but sales are picking up as banks are looking to shrink exposures.”

Although the troubled loans being offloaded represent only a small fraction of the approximately $2.5 trillion in commercial real estate loans held by U.S. banks, these steps signify a shift in strategy. As per the information contained in the NYT report, banks are moving away from the “extend and pretend” approach, where they extend loan terms in hopes that market conditions will improve, and towards acknowledging that many property owners, particularly those of office buildings, are likely to default.

This shift suggests that lenders are preparing for significant losses and are seeking to mitigate the impact on their earnings. As defaults on commercial real estate loans become more probable, banks are bracing for the inevitable financial fallout. The offloading of these loans is an attempt to manage and minimize future losses.

The commercial real estate market, particularly the office segment, is facing a prolonged period of adjustment. The pandemic has fundamentally altered work patterns, with many companies adopting hybrid or fully remote work models, reducing the demand for traditional office space. This structural change is expected to have long-term implications for the market.

Financial institutions are now recalibrating their strategies to adapt to these new realities. The offloading of troubled loans, while a defensive measure, also reflects a broader need for the industry to reassess the viability and valuation of commercial properties in the post-pandemic world.

For years, banks have extended the time that property owners have to find tenants for their partially empty office buildings, operating under the assumption that these extensions would give landlords the necessary time to stabilize their finances, the NYT report explained.  Additionally, lenders have been reluctant to push property owners to renegotiate expiring loans due to today’s higher interest rates. This approach, while providing temporary relief, has often postponed the inevitable reckoning with financial realities, the report in the NYT pointed out.

Banks are not acting out of altruism but rather from a calculated assessment of risk and loss. Foreclosing on delinquent borrowers or selling troubled loans at a substantial discount forces banks to recognize theoretical losses as real financial hits, as was detailed in the NYT report. Despite this, many banks now prefer to take a smaller, immediate loss rather than risk a more significant financial impact if market conditions continue to deteriorate.

Jay Neveloff, who leads the real estate legal practice at Kramer Levin, told the NYT, “The banks know they have too many loans on their books.” Neveloff explained that banks are increasingly testing the market to determine the level of discount necessary to attract buyers for their most troubled loans. He revealed to the NYT that he is currently representing several family office buyers who have been directly approached by major banks with offers to purchase discounted loans.

While the commercial real estate loan sector faces challenges, it has not yet reached a crisis level. The banking industry reported that just under $37 billion in commercial real estate loans, or 1.17 percent of all loans held by banks, were delinquent as of the most recent data, as was noted in the NYT report. This is a far cry from the peak delinquency rate of 10.5 percent seen in early 2010, following the 2008 financial crisis, according to S&P Global Market Intelligence.

To avoid alarming shareholders and the broader market, banks are opting to market these deals privately. According to Neveloff, banks are approaching a select group of brokers with instructions to keep these transactions under wraps. “The banks are going to a select number of brokers, saying, ‘I don’t want this public,’” Neveloff told the NYT. This discreet approach is intended to manage the optics of the situation and prevent a panic that could further destabilize the market.

The commercial real estate market continues to face significant headwinds, primarily driven by high interest rates and low occupancy rates, a legacy of the COVID-19 pandemic. These conditions make refinancing loans more challenging and reduce rental incomes, putting additional financial pressure on property owners and, by extension, their lenders.

In the aftermath of the collapse of First Republic and Signature Bank, both of which were major commercial real estate lenders, banks are facing increasing pressure from regulators and investors to reduce their exposure to commercial real estate loans, as was affirmed in the NYT report.  This pressure is particularly acute for regional and community banks, which hold a significant portion of these loans on their balance sheets.

Regulators are concerned about the potential risks posed by large concentrations of commercial real estate loans, especially given the current economic uncertainties. Indicated in the NYT report was that investors, similarly, are wary of the financial stability of banks heavily invested in commercial real estate, prompting a push for banks to divest these loans and reduce potential liabilities.

Regional and community banks, those with $100 billion in assets or less, account for nearly two-thirds of the commercial real estate loans held by banks, according to S&P Global Market Intelligence. The report in the NYT observed that many of these loans are concentrated in smaller community banks with less than $10 billion in assets, which lack the diversified revenue streams of larger financial institutions. This makes them particularly vulnerable to fluctuations in the commercial real estate market.

The commercial real estate market, especially the office sector, faces significant challenges. High interest rates and low occupancy rates continue to pressure property owners, making it difficult for them to refinance loans or maintain profitability. The NYT report said that as a result, hundreds of billions of dollars in office building loans are coming due over the next two years, according to Jonathan Nachmani, a managing director with Madison Capital.

Despite these challenges, banks have been reluctant to sell their commercial real estate loans en masse. This hesitation stems from the desire to avoid realizing losses and the lack of interest from big investors. “It’s because nobody wants to touch office,” Nachmani told the NYT, highlighting the widespread aversion to office loans due to the sector’s current instability.

However, there have been notable transactions indicating some level of institutional investor interest. One of the largest deals occurred last summer when Fortress Investment Group, a major investment management firm with $46 billion in assets, paid $1 billion to Capital One for a portfolio of commercial real estate loans, many of which were office loans in New York, according to the information in the NYT report.

Tim Sloan, vice chairman of Fortress and former CEO of Wells Fargo, stated that the firm is looking to buy office and debt from banks at discounted prices. However, Fortress is primarily interested in the higher-rated or less risky portions of these loans. Noted in the NYT report was that for investors such as Fortress, the appeal of purchasing discounted commercial real estate loans lies in the potential for significant value appreciation if the industry recovers in the next few years. Even in the worst-case scenario, investors can take possession of properties at discounted prices following foreclosures.

The ongoing sale of commercial real estate loans by banks reflects a broader shift in strategy as financial institutions seek to mitigate risks and comply with regulatory and investor pressures. While these sales can help banks reduce their exposure to troubled assets, they also highlight the underlying vulnerabilities in the commercial real estate market, particularly in the office sector, the NYT report observed.

In the broader market, some commercial real estate loan deals are being structured to minimize losses for individual buyers. For instance, in November, Rithm Capital and its affiliate, GreenBarn Investment Group, negotiated a deal with Goldman Sachs to acquire some of the highest-rated portions of a loan for Columbia Property Trust at a discount. The NYT report said that this real estate investment trust had defaulted on a $1.7 billion loan backed by seven office buildings in major cities such as New York, San Francisco, and Boston. The loan was originally arranged by Goldman Sachs, Citigroup, and Deutsche Bank, with each bank retaining portions of the loan on their books.

By March, GreenBarn had teamed up with two hedge funds to purchase similarly high-rated portions of the loan held by Citigroup. This strategic move not only infused new capital into the deal but also spread the risk among multiple firms, thereby reducing the potential losses for any single entity if mortgage payments did not resume, as was detailed in the NYT report.  Both Goldman Sachs and Citigroup declined to comment to the NYT on these transactions.

Michael Hamilton, co-head of the real estate practice at O’Melveny & Myers, has been involved in several deals where banks quietly gave borrowers a year to find buyers for their properties, even if this meant selling at substantial discounts, the report in the NYT said. The goal for banks is to avoid foreclosure, which can be costly and time-consuming. Borrowers benefit by being able to walk away from their mortgages without owing additional money. Hamilton highlighted the growing severity of the situation, telling the NYT, “The general public does not have a sense of the severity of the problem.”

The commercial real estate loan market is navigating through a precarious period, exacerbated by the aftermath of the pandemic and ongoing economic uncertainties. Banks and investors are employing various strategies to manage and mitigate risks associated with delinquent loans. These strategies include selling high-rated loan portions at discounts, partnering with other financial firms to distribute risk, and quietly extending timeframes for borrowers to find buyers.