Some of Wall Street's biggest commercial lenders have quietly begun selling off delinquent commercial loans. While these moves are happening quietly behind the scenes and don't involve entire portfolios, they may signal growing concern that some delinquent commercial loans will never be repaid because the office market may never recover. At the very least, these big banks appear to be taking steps to protect themselves against a worst-case scenario.
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The commercial sector has been a source of concern for economists and mortgage lenders since the pandemic ended, as once-full office space suddenly found itself empty as demand fell due to an increase in remote work. That's dire considering that while the national occupancy rate for the U.S. commercial market is just over 80%, commercial properties need to be 90% or higher to be profitable, according to a CommercialEdge National Office report.
Vacant office buildings don't even make mortgage payments. The amount of commercial debt on the books is so high that some economists believe it could trigger a major economic collapse. And yet, recent stress tests of America's largest banks have revealed that the risk is relatively small. Nevertheless, the Mortgage Bankers Association estimates that nearly $1 trillion in commercial loans will come due in 2024 alone.
With this in mind, some of the largest commercial lenders in the U.S. are aggressively selling off problem loans. The New York Times reports that Deutsche Bank, Goldman Sachs and Canadian-based lender CIBC have sold hundreds of millions of dollars worth of mortgages or parts of their mortgage portfolios since the second half of 2023. While they will likely incur losses by selling mortgages for less than the loan amount, selling loans now can reduce their risk.
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Once a loan defaults, a mortgage lender's only recourse is to sell the underlying asset. But mortgage lenders would almost certainly incur greater losses from selling a distressed asset than they would by selling a delinquent loan before it defaulted. This process could have been avoided in years past by allowing borrowers to refinance their loans.
Unfortunately, today's high interest rates make refinancing a financial disaster for building owners. To date, many banks have responded with a strategy known as a “sham extension,” in which the bank extends the borrower's current terms rather than calling on the loan. In theory, this gives the borrower time to increase occupancy and bring the loan current, but both parties know that's nearly impossible in today's market.
This is where the “show” element comes in. Such a wishful thinking strategy is unsustainable, and recent moves by large banks to liquidate some of their non-performing loans may be evidence of a course correction. Rather than extending loans to make them look good, some of these banks appear to be trying to cut their losses by selling non-performing loans before a flood of bad loans and non-performing assets simultaneously floods the market.
“Banks know they have too many outstanding loans,” Jay Neveloff, head of the law firm Kramer Levin's real estate practice, told The New York Times. Neveloff believes this is what prompts banks to contact his clients and offer to sell their loans at a discount. He told The New York Times that he is working on several transactions representing private buyers who have been contacted by large banks looking to sell.
At the same time, banks want to avoid the appearance of a fire sale while quietly selling risky loans. “They're asking a select number of brokers to say, 'We don't want to make this loan public,'” Neverov said. All parties involved in these deals appear to be walking a delicate balance between protecting their own interests and avoiding market panic. Time will tell how successful this strategy will be.
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