Commercial Real Estate: The Return Of 'Extend And Pretend'

seekingalpha04-09

Some commercial real estate markets continue to experience substantial deterioration, leading to rising default rates amid record office vacancy rates.This is increasingly putting additional stress on...

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href=https://seekingalpha.com/article/4682706-commercial-real-estate-the-return-of-extend-and-pretend><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Some commercial real estate markets continue to experience substantial deterioration, leading to rising default rates amid record office vacancy rates.This is increasingly putting additional stress on...</p>\n\n<a href=\"https://seekingalpha.com/article/4682706-commercial-real-estate-the-return-of-extend-and-pretend\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"LU1267930490.SGD","symbol_name":"TEMPLETON GLOBAL EQUITY INCOME \"AS\" (SGD) INC 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The return of 'Extend and Pretend' has also pushed many debt maturities into 2024.However, outside a near V-shaped recovery in commercial real estate, eventually some financial institutions will need to pay the piper.We take a look at the downtrend in many parts of the commercial real estate space and which banks could be impacted the most in the paragraphs below.   Bulgac Well, if there is one good thing about the substantial deterioration of key sectors of the commercial real estate, or CRE, market over the past few quarters, it is giving the financial writers at the NY Post plenty of fodder as loans on numerous skyscrapers succumbed to market forces and resulted in \"jingle mail.\" Last week, it was a $240 million mezzanine loan connected to Brooklyn's tallest building (93 stories) that went into default and now faces foreclosure.   March 2024 CMBS Delinquency Rate By CRE Asset Class (Trepp) It is almost we are in the early innings of \"housing bust\" from nearly two decades ago. Except this time, it is huge office buildings that are in the center of the storm and not residential homes. The delinquency rate for Commercial Mortgage-Backed Securities or CMBS have reached over 6.5%, from under two percent at the beginning of 2023. Lodging delinquencies have seen an uptick and are approaching 5.5% while retail CRE delinquency remains high. Many store fronts face myriad challenges. 99 Cent Stores announced last week they have chosen to liquidate their 371 locations as they file for bankruptcy. The company noted the challenges from inflation, increasing shrink and the impacts of the Covid pandemic among other issues forcing the decision. The retailer will also have to dispose of its industrial and distribution facilities. The deteriorating condition in many commercial real estate sectors is starting to ignite what is known as 'extend and pretend' behavior from financial institutions around loans against CRE. Banks' expected 2024 commercial real estate maturities rose by 35% compared to previous estimates, according to a recent report from PGIM Real Estate. MCSI Assets made a similar observation earlier this month. This is how CRE loan maturities went from just under an estimate $700 billion due in 2024 at the end of last year to a current projection of north of $900 billion. This situation is likely to worsen in the months as stress on certain parts of the CRE sector increase. Chicago just reported they now have a downtown office vacancy rate of just north of 25%, an all-time record. New York City, Los Angeles, San Francisco, Atlanta, Pittsburgh and many other major cities are all seeing similar duress. It is hard to see office property values or vacancy rates rising in the short or medium term given what seems the \"permanency\" of much expanded virtual workforce brought about from the aftermath of the Covid pandemic.   Office Vacancy Rates In major U.S. Cities (Savillis, WolfStreet.com) Nor will the Federal Reserve be riding to the rescue of the CRE sector with a series of interest rate cuts as I highlighted in this recent article. Today, we will focus on how rising CRE default rates could impact various banks once extend and pretend collides with eventual reality.   March 2024 - Visual Capitalist The good news is that the major banks, a key epicenter of the Great Financial Crisis, have relatively little exposure within their loan books to CRE. On average, CRE only makes up approximately 11% of their loan balances with major banks like Bank of America (BAC) and Citigroup (C) having exposures in the single digits and JPMorgan Chase & Co. (JPM) being in the low teens. Wells Fargo & Company (WFC) has the highest exposure among the large money center banks with just north of 21% of its loan book in CRE loans. While rising CRE default rates and credit loss provisions will ding bank earnings, there is nothing here that should result in major impacts to the banking or financial systems like in 2008 and 2009. Unfortunately, other parts of the banking system are unlikely to come through the continued deterioration of commercial real estate unscathed. Hundreds of small and community banks will likely fail over the coming few years thanks to their outsized CRE exposure. Some will be liquidated, and some will merge with larger banking concerns. This will primarily impact the local communities where these institutions are located. This will have some negative effects to the small businesses and individuals these institutions previously served. However, they should not have any many impacts on the overall banking system as the number of overall banks in the country has been shrinking for decades now. It is the regional banks I am most concerned about. First, because many have substantial CRE exposure and multiple failures could trigger at least a minor credit crunch in parts of the economy, with small business being particularly impacted. In addition, many of these financial institutions were already challenged from the large \"unrealized\" losses on their bond portfolios thanks to the huge rise in rates since the Federal Reserve began their monetary tightening in March of 2022. This is what triggered events that led to the failures of Silicon Valley Bank, First Republic and Signature Banks in the first half of 2023 that also led to a temporary but noticeable spike in volatility in the markets a year ago. Those issues still exist, making banks more vulnerable to increasing CRE default rates and credit losses.   Seeking Alpha And outside a near V-shaped recovery in parts of commercial real estate, \"extend and pretend\" can only bring a temporary respite for borrowers and the financial institutions that hold that debt. Investors saw this in action with the near explosion of New York Community Bancorp, Inc. (NYCB) earlier this year. This regional bank was saved, at least for the moment, by a hastily put together $1 billion equity infusion. Even with that, shareholders have seen two thirds of their value lost so far in 2024. The emerging saga of NYCB produced a small blip in volatility for the markets in late January/early February. I think we are in the early innings of this CRE debt meltdown and will see another few NYCB like situations emerge before the year is out. This is one reason I have a small short position via long dated out of the money bear put spreads against the SPDR® S&P Regional Banking ETF (KRE). I also have a similar small short position against Bank OZK (OZK), a regional bank that has been significantly involved financing the huge building boom a large part of Miami is experiencing. 50 to 90 story skyscrapers under construction are once again heavily dotting the skyline of Brickell, Wynwood, Downtown Miami and Edgewater, like all of the lessons from the housing bust of 15 years ago have been long forgotten here in South Florida. More importantly, just over two-thirds of Bank OZK's just over $32 billion loan book is in CRE debt. Therefore, it is a 'canary in the coalmine' stock, whose shares should fall should the CRE space significantly deteriorate from here, which seems likely. To put in perspective, just under 60% of NYCB's loan book was in CRE debt before it hit its recent air pocket. Pacific Premier Bancorp (PPBI) and Home BancShares (HOMB) are two other regional names with just over 60% of their loan books against CRE* *As of the end of the third quarter.  And that is what I am watching as more banks embrace \"extend and pretend.\" Office vacancy rates stand at record highs in major cities, and debt maturities come due at a time of considerable and worsening stress in many parts of commercial real estate.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2426160792"}