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Delinquencies on commercial real estate loans at U.S. banks have reached their highest level in a decade as rising interest rates, economic uncertainty and an increase in remote work have increased pressure on building owners.
The total value of delinquent loans, where owners have missed at least one payment on property they rented out to others, rose 30%, or $4 billion, to $17.7 billion in the three months to the end of September, according to industry research firm BankRegData, a figure that represents a $10 billion increase in one year.
Bank lending remains strong by historical standards, and even after a recent surge, delinquency rates for commercial real estate loans stand at just 1.5%.But industry watchers say the number of properties under pressure is likely to keep growing, particularly in the office sector.
Bill Moreland, who runs BankRegData, told clients that commercial real estate lending is “deteriorating rapidly.”
“This is not a temporary problem. It's not going to be a COVID-19 crisis and then it's going to bounce back,” said Leo Huang, head of commercial real estate debt at asset manager Ellington Management Group Inc. “Property prices are going to fall and delinquencies are going to continue to rise.”
The third-quarter data does not reflect the impact of desk-rental company WeWork's bankruptcy filing this week, the largest office tenant in cities from New York to San Francisco.
The Chapter 11 bankruptcy filing, at least in the U.S., will allow WeWork to streamline its portfolio by exiting many leases with little or no financial penalty, putting pressure on building owners.
Wells Fargo cited WeWork's troubles as one of the reasons it recently put a $20.5 million mortgage on 599 Broadway, a mid-sized office building in lower Manhattan, on a watch list of loans it fears might default on. The loan was made by Bank of America but has since been sold to investors and is being repaid by Wells.
Wells has more than $70 billion in commercial real estate loans, making it the nation's largest lender in that sector and therefore most at risk for real estate-related losses. The company's delinquent real estate loan balance rose more than 50% to $3.4 billion in the third quarter, from just $400 million a year earlier.
Despite rising delinquencies, Wells and other banks have been reluctant to force borrowers into default or declare actual losses on their growing piles of delinquent loans. Wells wrote off just $91 million in CRE loans in the third quarter.
On a conference call with analysts last month, Wells expressed optimism that many of those borrowers would resume payments or avoid losses, but bank executives reiterated that there would be some impact. “We haven't seen any material losses yet, but we will,” said Mike Santomasimo, Wells' Chief Financial Officer.
Kevin Fagan, head of commercial real estate economic analysis at Moody's, said he expects delinquency rates to rise for at least the next 12 months. “The pain is coming,” he said, but added that it will take time for delinquencies to translate into losses.
Among regional banks, Pittsburgh-based PNC saw the biggest jump in delinquencies on commercial real estate loans, which more than doubled to $723 million in the quarter. “The pressures we expected in our commercial real estate office segment are starting to materialize,” PNC Chief Financial Officer Rob Reilly told analysts last month. But he added that the bank has enough reserves to cover potential losses on those loans.
Other banks are also focusing on restructuring real estate loans to avoid losses. At Bank of America, the value of modifications to real estate loans, in which the bank waived interest or extended payment terms, rose by nearly $750 million in the quarter to $1.2 billion. Industry-wide, the value of restructured commercial real estate loans rose by $6 billion over the past six months to $8.5 billion.
“Banks will extend loans if they think the assets can be saved,” said Christopher Whalen, a veteran banking analyst and president of Whalen Global Advisors. “If the banks have to take the buildings back, the value could drop in half.”