Fearing losses, banks are quietly disposing of mortgage loans

Some Wall Street banks, concerned that owners of vacant and distressed office buildings won’t be able to repay their mortgages, have begun emptying their portfolios of commercial real estate loans in hopes of cutting their losses.

It’s an early but indicative sign of the broader malaise brewing in the commercial real estate market, which is hurting by the double whammy of high interest rates, which make it difficult to refinance loans, and low occupancy rates for office buildings — a result of the recession. pandemic.

Late last year, a subsidiary 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 group of distressed office buildings in New York, San Francisco and Boston. In May, Canadian bank CIBC completed the sale of $300 million of mortgages on a group of office buildings across the country.

“What you’re seeing now is a one-time event,” said Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence.

Sales are starting to rise because “banks are looking to reduce exposure,” Mr. Stovall said.

In number and value, the distressed commercial loans that banks are trying to eliminate are a small fraction 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 these steps indicate that some lenders have reluctantly accepted that the banking industry’s “expand and pretend” strategy is running out of steam, and that many landlords – especially office building owners – will default on their mortgage payments. This means that large losses to lenders are inevitable and that banks’ profits will suffer.

Banks regularly “extend” the time that distressed landlords have to find rent-paying tenants for their half-empty office buildings, and “pretend” that the extensions will allow landlords to get their finances in order. Lenders also avoided pushing landlords to renegotiate expired loans, given today’s much higher interest rates.

But banks act out of self-interest and not out of compassion for borrowers. Once a bank forecloses on a delinquent borrower, it faces the possibility of a theoretical loss turning into a real loss. Something similar happens when a bank sells a delinquent loan at a significant discount to the outstanding balance. But in the bank’s calculations, taking a loss now is still better than risking a deeper hit if the situation deteriorates in the future.

Although the problems with commercial real estate loans are bad, they have not yet reached crisis levels. The banking industry recently reported that just under $37 billion of commercial real estate loans, or 1.17% of all loans held by banks, were delinquent — meaning the loan payment was more than 30 days delinquent. In the wake 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.

Banks have begun running checks to see what kind of discount would be necessary to entice investors to buy the worst of the lot, Mr. Nevilov said. Mr. Nevilov said he is acting on behalf of several family office buyers who have been approached directly by a few major banks seeking deals to buy discounted loans.

He said that banks currently tend to market deals privately so as not to attract too much attention and possibly scare away shareholders.

“Banks are turning to a select number of intermediaries, saying: ‘I don’t want this audience,’” Nefilov said.

Banks are also feeling pressure from regulators and their investors to trim their real business loan portfolios — especially in the wake of the collapses of First Republic and Signature Bank last year. Both were major commercial real estate lenders.

Regional and community banks — those with assets of $100 billion or less — account for nearly two-thirds of the commercial real estate loans on banks’ balance sheets, according to S&P Global Market Intelligence. Many of these loans are owned by community banks with less than $10 billion in assets, which lack the diversified revenue streams that larger banks enjoy.

Hundreds of billions in office construction loans will come due in the next two years, said Jonathan Nahmani, managing director of Madison Capital, a commercial real estate investment and financing firm. He said that banks do not sell loans en masse because they do not want to bear losses and there is not enough interest from large investors.

“The reason is that no one wants to touch his position,” said Mr. Nahmani, who oversees the company’s acquisitions.

One of the largest institutional investor deals for commercial real estate loans occurred 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 are office loans in New York.

Tim Sloan, vice chairman of Fortress and former CEO of Wells Fargo, said the investment firm is looking to buy office space and debt from banks at discounted prices. But the company is mainly interested in purchasing the highly rated or less risky portions of the loan.

For investors, the appeal of taking out discounted commercial real estate loans is that the loans could be worth much more if the industry rebounds in the next few years. In the worst-case scenario, buyers take ownership of the building at a reduced price after 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 he took out last year from Deutsche & Arial Bank, a small German bank with an office in New York, according to court papers filed in Manhattan Supreme Court. 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 commercial real estate loan deals are structured in ways that will minimize losses for any single buyer.

In November, Rithm Capital and its affiliate, GreenBarn Investment Group, negotiated a deal with Goldman Sachs to acquire at a discount some of the top-rated portions of a loan for an office-building investment vehicle called Columbia Property Trust, three people familiar with the matter said. . Subject.

Columbia real estate, real estate investment trust, Last year, it defaulted on a $1.7 billion loan It was arranged by Goldman, Citigroup and Deutsche Bank. The loan was backed by seven office buildings in New York, San Francisco, and Boston, and the three banks kept some portions of this loan on their books.

In March, GreenBarn then partnered with two hedge funds to buy similarly highly rated portions of the loan on Citi’s books, the people said.

In doing so, GreenBarn not only brought new money into the deal, but also spread the risk among several companies — reducing the total amount any one company could lose if its mortgage payments didn’t start up again.

Both Goldman and Citi declined to comment.

Michael Hamilton, one of the heads of O’Melveny & Myers’ real estate practice, said he has been involved in a number of deals in which banks quietly give borrowers a year to find a buyer for the property — even if it means the building is sold at a deep discount. Banks are interested in avoiding foreclosure and borrowers benefit by walking away from a mortgage without owing anything, he said.

“What I saw was the cockroaches starting to come out,” Mr Hamilton said. “The general public has no sense of the seriousness of the problem.”

Julie Cresswell Contributed to reports.