Some Wall Street banks, worried that owners of vacant and struggling office buildings won’t be able to pay their mortgages, have begun offloading their commercial real estate loan portfolios, hoping to cut their losses.
It’s an early sign, but indicative of broader distress in the commercial real estate market, which is hurting from the twin shocks of high interest rates that make it harder to refinance loans and low rates. of utilization for office buildings – a result of the pandemic.
Late last year, an affiliate of Deutsche Bank and another German lender sold the delinquent mortgage on the Argonaut, a 115-year-old office complex in midtown Manhattan, to the family office of billionaire investor George Soros, according to court filings.
Around the same time, Goldman Sachs sold the loans it held on a portfolio of distressed office buildings in New York, San Francisco and Boston. And in May, Canadian lender CIBC completed a $300 million sale of mortgages on a collection of office buildings across the country.
“What you’re seeing right now are biases,” said Nathan Stovall, director of financial institutions research for S&P Global Market Intelligence.
Mr. Stovall said sales were increasing as “banks are looking to shrink exposures.”
In terms of number and value, the troubled commercial loans banks are trying to offload are a sliver 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 show a vague acknowledgment by some lenders that the banking industry’s “stretch and pretend” strategy is running out and that many property owners – especially office building owners – will default on their mortgages. This means that huge losses for lenders are inevitable and bank income will suffer.
Banks regularly “extend” the time that struggling property owners have to find rent-paying tenants for their half-empty office buildings and “claim” that the extensions will allow the owners to fix their finances. Lenders have also avoided pushing property owners to renegotiate expiring loans, given today’s much higher interest rates.
But the banks are acting out of self-interest and not out of pity for the borrowers. Once a bank abandons a delinquent borrower, it faces the prospect of a theoretical loss turning into a real loss. A similar thing happens when a bank sells a delinquent loan at a significant discount to the debt balance. However, in the bank’s calculation, taking a loss now is still better than risking a deeper blow if the situation worsens in the future.
The problems with commercial real estate loans, while bad, have not yet reached a crisis level. The banking industry recently reported that just under $37 billion in commercial real estate loans, or 1.17 percent of all loans held by banks, were delinquent — meaning the loan payment was more than 30 days late. In the aftermath of the 2008 financial crisis, delinquencies on commercial real estate loans at banks peaked at 10.5 percent in early 2010, according to S&P Global Market Intelligence.
“Banks know they have a lot of loans on their books,” said Jay Neveloff, who heads the real estate law practice at Kramer Levin.
Mr. Neveloff said banks are starting to look at what kind of discount would be needed to entice investors to buy the worst of the series. Mr Neveloff said he is working on behalf of several family office buyers who have been approached directly by several large banks with deals to buy discounted loans.
Right now, he said, banks are inclined to trade private deals so as not to attract too much attention and potentially scare their shareholders.
“Banks will go to a select number of brokers, saying: ‘I don’t want this public,'” said Mr. Neveloff.
Banks are also feeling pressure from regulators and their investors to reduce their commercial real loan portfolios — particularly in the wake of last year’s collapse of First Republic and Signature Bank. Both had been large commercial real estate lenders.
According to S&P Global Market Intelligence, regional and community banks — those with $100 billion or less in assets — account for nearly two-thirds of commercial real estate loans on bank balance sheets. And many of these loans are held by community banks that have less than $10 billion in assets and lack the diversified revenue streams of much larger banks.
Jonathan Nachmani, a managing director of Madison Capital, a commercial real estate investment and finance firm, said hundreds of billions in office building loans will come due in the next two years. He said that banks have not sold loans in bulk because they do not want to take losses and there is not enough interest from large investors.
“It’s because no one wants to touch the office,” said Mr. Nachmani, who oversees acquisitions for the firm.
One of the largest institutional investor deals in commercial real estate loans happened last summer when Fortress Investment Group, a large investment management company with $46 billion in assets, paid $1 billion to Capital One for a portfolio of loans , many of them office loans in New York.
Tim Sloan, a Fortress vice chairman and former Wells Fargo chief executive, said the investment firm was looking to buy offices and debt from banks at discounted prices. But the firm is primarily interested in buying the highly rated or less risky parts of a loan.
For investors, the appeal of taking out commercial real estate discount loans is that the loans could be worth much more if the industry recovers in the coming years. And in the worst case scenario, buyers take possession of a building at a discounted price after a foreclosure.
That’s the scenario playing out with the Argonaut building at 224 West 57th Street. In April, Mr. Soros’ family office moved to foreclose on a delinquent loan it received last year from Deutsche and Aareal Bank, a small German bank with an office in New York, according to court documents filed with the U.S. Supreme Court. Manhattan. One of the building’s tenants is Mr. Soros’s charitable group, the Open Society Foundations. A spokesman for Mr. Soros declined to comment.
Some of the commercial real estate loan deals are being structured in ways that would minimize losses for any buyer.
In November, Rithm Capital and an affiliate, GreenBarn Investment Group, negotiated a deal with Goldman Sachs to buy at a discount some of the highest-rated parts of a loan for an office building investment vehicle called Columbia Property Trust, three of the people said. informed about the Case.
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 backed by seven office buildings in New York, San Francisco and Boston, and all three banks had some portion of that loan on their books.
In March, GreenBarn then partnered with two hedge funds to buy similar shares with high credit ratings that were on Citi’s books, the people said.
In doing so, GreenBarn not only brought new money to the deal, but also spread the risk among several firms—lowering the total amount each firm could lose if mortgage payments did not resume.
Goldman and Citi declined to comment.
Michael Hamilton, one of the heads of the real estate practice at O’Melveny & Myers, said he has been involved in a number of deals in which banks quietly give borrowers a year to find a buyer for a property – even if it means a building is sold at a significant discount. He said banks are interested in avoiding a foreclosure and borrowers benefit by walking away from a mortgage without having any debt.
“What I’ve seen is that the roaches are starting to come out,” Mr Hamilton said. “The general public doesn’t have a sense of the severity of the problem.”
Julie Creswell contributed to the reporting.