Some Wall Street banks, concerned that owners of vacant and distressed office buildings would be unable to pay their mortgages, have begun shedding their commercial real estate loan portfolios in hopes of reducing their losses.
It’s an early but telling sign of the broader distress brewing in the commercial real estate market, which is suffering the double whammy of high interest rates, which make it harder to refinance loans, and low occupancy rates in office buildings – a result of the pandemic.
Late last year, a Deutsche Bank subsidiary and another German lender sold the defaulted mortgage on the Argonaut, a 115-year-old office complex in midtown Manhattan, to the family office from billionaire investor George Soros, according to court filings.
Around the same time, Goldman Sachs sold the loans it held on a portfolio of troubled office buildings in New York, San Francisco and Boston. And in May, Canadian lender CIBC completed the sale of $300 million in mortgages on a collection of office buildings across the country.
“What you’re seeing right now are isolated cases,” said Nathan Stovall, director of financial institutions research for S&P Global Market Intelligence.
Mr Stovall said sales were picking up as “banks look to reduce their exposures”.
In terms of number and value, the distressed commercial loans that banks are trying to offload represent only a tiny portion of the roughly $2.5 trillion in commercial real estate loans held by all banks in the United States, according to S&P Global Market Intelligence.
But the moves indicate that some lenders are grudgingly accepting that the banking industry’s strategy of “stretch and pretend” is running out of steam and that many property owners – particularly office building owners – will default on their loans. mortgages. This means big losses for lenders are inevitable and banks’ profits will suffer.
Banks routinely “extend” the time struggling landlords have to find paying tenants for their half-empty office buildings, and “claim” that these extensions will allow landlords to get their finances in order. Lenders have also avoided pushing homeowners to renegotiate their maturing loans, given today’s much higher interest rates.
But banks act in their own self-interest rather than out of pity for borrowers. Once a bank forecloses on a defaulting borrower, it risks seeing a theoretical loss turn into a real loss. A similar situation occurs when a bank sells a defaulted loan at a significantly discounted price from the balance owed. However, according to the bank’s calculations, it is still better to take a loss now than risk a bigger hit if the situation deteriorates in the future.
The problems with commercial real estate lending, while serious, have not yet reached crisis level. The banking industry recently reported that just under $37 billion in commercial real estate loans, or 1.17% of all loans held by banks, were delinquent, meaning a loan was overdue by more than 30 days. In the wake of the 2008 financial crisis, commercial real estate loan delinquencies at banks peaked at 10.5% in early 2010, according to S&P Global Market Intelligence.
“The banks know they have too many loans on their books,” said Jay Neveloff, who runs the real estate law practice at Kramer Levin.
Mr. Neveloff said banks were starting to test what kind of haircut would be needed to entice investors to buy the worst of the lot. Mr. Neveloff said he worked on behalf of several family office buyers who were approached directly by a few big banks with deals to buy discounted loans.
Right now, he says, banks tend to do deals privately so as not to attract too much attention and potentially scare off their own shareholders.
“The banks are going to a number of brokers and saying, ‘I don’t want this audience,'” Mr. Neveloff said.
Banks are also feeling pressure from regulators and their own investors to reduce their actual commercial loan portfolios – particularly following last year’s collapse of First Republic and Signature Bank. Both were major commercial real estate lenders.
Regional and community banks — those with $100 billion in assets or less — account for nearly two-thirds of commercial real estate loans on bank balance sheets, according to S&P Global Market Intelligence. And many of these loans are held by community banks that have less than $10 billion in assets and don’t have the diversified revenue streams of much larger banks.
Jonathan Nachmani, chief executive of Madison Capital, a commercial real estate investment and financing firm, said hundreds of billions in office construction loans will mature over the next two years. He explained that banks have not sold loans en masse because they do not want to take losses and there is not enough interest from large investors.
“It’s because no one wants to gain power,” said Mr. Nachmani, who oversees the company’s acquisitions.
One of the largest institutional investor transactions in commercial real estate loans took place last summer when Fortress Investment Group, a large investment management firm with $46 billion in assets, paid $1 billion to Capital One for a portfolio of loans, many of which were office loans in New Zealand. York.
Tim Sloan, a vice president at Fortress and former chief executive of Wells Fargo, said the investment firm was looking to buy office space and debt from banks at discounted prices. But the company is primarily interested in buying the highest-rated or least risky parts of a loan.
For investors, the appeal of discounted commercial real estate loans is that these loans could be worth significantly more if the industry recovers in the coming years. And in the worst case scenario, buyers can take possession of a building at a reduced price following a foreclosure.
This is the scenario playing out with the Argonaut building at 224 West 57th Street. In April, Mr. Soros’s family office decided to seize the defaulted loan he acquired last year from Deutsche and Aareal Bank, a small German bank with an office in New York, according to officials. court documents filed in Manhattan Supreme Court. One of the building’s tenants is Mr. Soros’s charitable group, Open Society Foundations. A spokesman for Mr. Soros declined to comment.
Some commercial real estate loan transactions are structured to minimize losses for any buyer.
In November, Rithm Capital and an affiliate, GreenBarn Investment Group, negotiated a deal with Goldman Sachs to acquire at a discount some of the highest-rated portions of a loan for an office building investment vehicle called Columbia Property Trust , said three people briefed on the matter.
Columbia Property, a real estate investment trust, defaulted last year on a $1.7 billion loan arranged by Goldman, Citigroup and Deutsche Bank. The loan was secured by seven office buildings in New York, San Francisco and Boston and the three banks retained a portion of this loan on their books.
In March, GreenBarn then teamed up with two hedge funds to buy equally highly rated portions of the loan that was on Citi’s books, the sources said.
In doing so, GreenBarn not only brought in new money for the transaction, but also spread the risk across multiple companies, reducing the total amount a company could lose if mortgage payments did not resume.
Goldman and Citi declined to comment.
Michael Hamilton, one of the heads of the real estate department at O’Melveny & Myers, said he had been involved in a number of transactions in which banks quietly gave borrowers a year to find a buyer for a property – even if it means a building is sold at a substantial discount. He said banks want to avoid foreclosure and borrowers take advantage by being able to walk away from a mortgage without owing anything.
“What I’ve seen is the cockroaches are starting to appear,” Mr. Hamilton said. “The general public is not aware of the seriousness of the problem.”
Julie Creswell reports contributed.