Office property meltdown is starting to surface at regional banks
Neil Callanan and Patrick Clark
Updated 5 min read
(Bloomberg) — Slumping office property values are rippling through US banks, with smaller lenders in particular ramping up the use of loan modifications in their commercial real estate books.
The typical bank with less than $100 billion of of assets modified 0.32% of its CRE loans in the first nine months of the year, a Moody’s Ratings report found. That’s a big increase from the first half of 2024, when it was just about 0.1%.
But it’s also a far lower percentage than other kinds of lenders have modified: for medium-sized banks, the share was 1.93% in the first nine months, and for the biggest, it’s 0.79%, the report found. The difference is probably not because smaller lenders made better loans, but rather, because they have been slower to confront declining commercial property prices.
Modifications are typically sought by struggling landlords looking to put off making payments and get short-term extensions on loans. Their increased use is the latest sign of rising distress in CRE credit as a wave of loans come due for refinancing.
Much of the focus is on regional banks, which are especially vulnerable because they often took lower down payments than their larger counterparts in the years leading up to the interest-rate hikes that began in 2022. That means they have less of a buffer before taking losses after office and apartment complex values fell at least 20% since the peak.
At the same time, the bigger US lenders, which are subject to stress tests and other forms of intense regulatory scrutiny, have so far been setting aside more money to cover bad loans than smaller banks, according to Rebel Cole, a finance professor at Florida Atlantic University who also advises Oaktree Capital Management LP.
Concerns about future losses have contributed to stock price underperformance for smaller banks, with the KBW Regional Banking Index gaining about 17% this year compared with around 30% for the KBW Nasdaq Global Bank Index.
About $500 billion of CRE mortgages will mature in the next year “and a significant portion of them are going to go into default,” Florida Atlantic University’s Cole said. “There are going to be fire sales. They’re gonna put more downward pressure on commercial real estate prices across the board.”
Federal Deposit Insurance Corp. Chairman Martin Gruenberg warned on Thursday that weaknesses in some loan portfolios in the banking system, including offices and multifamily, continue to warrant close monitoring.
Office loans will plague public mortgage REITs and the vast majority of banks for a long time to come, Mike Comparato, president of Franklin BSP Realty Trust Inc., told analysts last month. Those assets are trading “at levels that were simply unfathomable a few years ago. We are also hearing anecdotes of lenders unwilling to take title to office assets to avoid the mark-to-market realities.”
Adding to the pain for lenders, this year’s interest-rate cuts by the Federal Reserve haven’t flowed through to lower long-term borrowing costs. That makes it more difficult for landlords to refinance their debt at a level that can be covered by the rental income.
“There’s starting to be some capitulation,” said Robin Potts, the chief investment officer at the real estate unit of special situations investor Canyon Partners LLC. “Borrowers who aren’t making payments can’t extend forever.”
Week in Review
Insurance brokerage firm Arthur J. Gallagher led dozens of companies teeing up billions of dollars of bond and loan sales in the US, looking to tap growing investor demand before markets close for the year. High-grade sales totaled $18 billion, while leveraged loans saw $75 billion of launches.
Some asset managers are juicing the yields in fixed-maturity funds by buying bonds that don’t have any set redemption dates.
Restaurant chain PF Chang’s China Bistro Inc. wants to ease short-term debt pressures by extending the maturity of a loan due in 2026, a move that could help improve its credit rating.
Kroger Co. has become the latest company that may be forced to buy back debt from investors after its attempt to purchase Albertsons Cos. was blocked by judges.
Thames Water is offering sweeteners to its most senior creditors in exchange for their support for its plan to raise £3 billion ($3.8 billion) of emergency cash.
Retailers Party City and Container Store, as well as prison-phone company Aventiv Technologies, are mulling bankruptcies.
As India’s growing wealth fuels demand for long-term savings products, a group of investors are asking the Reserve Bank of India to allow state government debt to be turned into zero-coupon bonds.
Sinclair Inc. and some of its lenders are hashing out a proposal to raise more than $1 billion in new financing to pay down some of its debt, according to people familiar with the situation.
Australia’s financial regulator pushed ahead with plans to become the first country to phase out the kind of securities that were wiped out at Credit Suisse last year.
Mars Inc. is seeking to raise at least $1 billion through the sale of private debt ahead of its acquisition of foodmaker Kellanova. The company is separately readying an investment-grade bond sale to help fund the acquisition.
Altice France and a group of secured creditors remain at odds over the terms of a deal to cut the company’s €23.7 billion ($24.9 billion) debt pile, including how much equity billionaire owner Patrick Drahi should give up.
On the Move
RBC Capital Markets named Michael Heuff as US head of leveraged finance and Mark Pepe as US co-head of leveraged finance capital markets alongside John Rote.
Edmond de Rothschild Asset Management hired Vianney Hocquet as hybrid corporate debt portfolio manager.
Mesirow Financial hired Jason Handrinos as senior managing director, global head of fixed income sales and growth on the firm’s institutional sales and trading team.
