The past few years haven't been easy for the commercial real estate industry. Many businesses have recently been downsizing their offices and exiting larger leases. At the same time, building owners are facing rising interest rates on their mortgages.
These pressures are not just a problem for owners of office buildings and other commercial real estate: They are also a concern for lenders with large amounts of commercial real estate debt on their balance sheets.
Commercial real estate loans don't work exactly the same way as residential mortgages: Mortgage interest rates are typically fixed by the borrower for 30 years, whereas commercial loans often must be renewed with a new interest rate about every five years.
“Many of the loans currently on the books were originated or disbursed when interest rates were super low,” said Dominic Mjaltan, CEO of Optus Bank in South Carolina.
Many of Myalta's commercial real estate loans are coming up for renewal in the next year or two. In fact, real estate data firm Trepp estimates that a record amount of CRE debt will mature this year.
“That's the scary thing, the bubble is coming,” Mjartan said.
Mjaltan added that this is scary because with current high interest rates, borrowers may not be able to repay. In a worst-case scenario, banks may be forced to foreclose, which is not something any lender wants.
“It's destructive, and it really eats at you,” Mjaltan said. “This process destroys the value of the community and really destroys the chances that borrowers, the customers we want to help, will get back on their feet.”
So Mjaltan said he and other lenders like him will do everything they can to avoid foreclosure. For example, lenders and borrowers can work out the terms of a loan to get a more favorable deal. But there are limits to what banks can do, Mjaltan said.
“If you don't do it on market-rate terms, then when auditors, loan officers and examiners come to look at your portfolio, they're going to scrutinize it very closely to see if you're hiding problematic debt,” Mjaltan said.
The Federal Deposit Insurance Corp. last month warned banks to keep tight control over risk management and closely monitor borrowers' property values.
A big concern is whether banks will be able to absorb the hit if some of their loans go bad, said Katherine Judge, a professor at Columbia Law School.
The Federal Reserve has said delinquencies on commercial real estate loans have risen over the past year, and regulators are concerned about what would happen if those delinquencies turn into defaults, Judge said.
“So what you're going to have is some banks that have lent a lot of money to commercial real estate, some of them probably smaller banks or regional banks, and suddenly a lot of the loans in their portfolios default at the same time,” Judge said.
Some lenders don't need to worry about the weakest parts of the commercial real estate sector.
“To be honest with you, there are no big office tower loans in my area,” said Brad Bolton, CEO of Community Spirit Bank, which serves customers in northwest Alabama and northeast Mississippi. “They just don't exist.”
Bolton said the bank's commercial real estate loans are made primarily to local businesses — grocery stores, hardware stores, medical clinics and the like — that are doing well.
“Our economy is doing very well,” he said. “Unemployment remains very low in the four counties that I serve.”
Still, Bolton acknowledged that banks are working harder to help borrowers afford higher interest rates.
Nathan Rogge, CEO of First Pacific Bank of Southern California, is running numerous stress tests with borrowers to gauge what would happen if interest rates and vacancy rates rose further.
“It assumes there will be some vacancy,” Rogge said. “If an office building is 95 percent occupied, what happens if it's 50 percent occupied?”
Rogge said the bank is also reconsidering the types of new commercial properties it will lend to.
“They're not as keen to go into office space for new lending compared to other uses such as manufacturing or lab space,” Rogge said.
That's because those types of properties haven't suffered the same downturn as office space, he added.
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