Commercial Real Estate Lending Headwinds, the 2024 Regulatory Focus on Credit Risk and Liquidity, and What You Need to Know.

Industry Analysis from CUinfluentialsm

 

Credit Union Commercial Real Estate Loan Portfolios are under pressure. The troubled  commercial real estate market is facing a record volume of maturing loans, significantly increasing prospects for a surge in defaults as property owners are  forced to refinance at higher rates. Heightened regulatory focus on credit risk and liquidity signal the need for preemptive strategies. Here we present a viable solution for Credit Unions.

 

What brought us to this point?

Credit Union loans secured by commercial real estate have grown to $141.5 billion (92.5% of all Credit Union commercial loans) as of the end of the third quarter of 2023. This represents a growth of $54.9 billion  - a 64% increase - since the fourth quarter of 2020. Due to a number of factors discussed below, many of these CRE loans may be under significant pressure, requiring Credit Unions to take immediate steps to protect credit risk and liquidity.

​

The pressure on CRE has been created by a convergence of factors, including a sharp increase in interest rates, rising costs and reduced operating margins, income pressure, tighter financing needs and a wall of debt maturing over the next 18 months…The imminent refinancing needs of CRE owners are another source of stress in the sector, with nearly $1.1 trillion worth of commercial mortgage loans expected to mature before the end of 2024, according to Goldman Sachs Global Investment Research. Given the balloon maturities common in commercial mortgages, many borrowers will have to refinance their existing loans at higher rates.

The Fed has hiked interest rates 11 times since January 2022 to curb inflation, making CRE credit tighter.  The collapse of Silicon Valley Bank, Signature Bank and First Republic Bank in March 2023 worsened the crisis.  Lenders’ caution is reflected in stringent credit policies, with loans originated only to those borrowers who have demonstrated strong creditworthiness.

There are substantial CRE loans maturing in the next two to three years.  The CRE sector is likely to face a significant challenge, as, based on current market conditions, low-interest loans mature at higher rates, increasing the difficulty in refinancing.  Increasing defaults at maturity would affect the weaker CRE assets, depending on asset quality, type and location.

 

Where are we now?

 

Credit Unions will need to maintain strong liquidity risk management in 2024, due to increased uncertainty in interest rates and market conditions. (NCUA Letter to Credit Unions January 24-CU-01)

 

This month the NCUA issued its supervisory priorities for 2024, stating that “Economic conditions continue to change the credit risk environment in the Credit Union industry as inflation, high interest rates and borrowing costs, declining savings levels, and the end of pandemic-era stimulus and relief programs have negatively impacted some members’ ability to repay their debts. Credit unions’ loan programs expanded faster during 2022 than any year within the last 30 years, while aggregate loan performance began showing signs of deterioration in 2023.  NCUA examiners will review existing lending programs’ soundness and Credit Union risk management practices, including any adjustments a Credit Union made to loan underwriting standards, portfolio monitoring practices, modification and workout strategies for borrowers facing financial hardships, and collection programs”

Credit unions will need to maintain strong credit and liquidity risk management in 2024, due to increased uncertainty in interest rate levels and economic conditions…Member behaviors and risk relationships are also changing, thus requiring a greater focus on forecasting assumptions, forward-looking cash flows and risk projections. The combined affect creates liquidity challenges and increased risk to earnings and capital. Increased liquidity risk and uncertainty heighten the need for Credit Unions to prepare for contingency funding needs. (Emphasis added.)

According to a January 16, 2024 article in the Wall Street Journal, the troubled  commercial real estate market is facing a record volume of maturing loans, significantly increasing prospects for a surge in defaults as property owners are  forced to refinance at higher rates.

​

WSJ notes that in 2023, “$541 billion in debt backed by office buildings, hotels,  apartments and other types of commercial real estate came due, the highest  amount ever for a single year. Commercial-debt maturities are expected to  continue rising, with more than $2.2 trillion coming due between now and the end  of 2027”. 

Compared to home mortgages, commercial loans have much shorter duration and  typically end with a balloon payment for the remaining value of the property. Few  owners can afford to pay off the full value, so refinancing is expected. When lower  valuations meet significantly higher interest rates and more restrictive underwriting  standards, “the math isn’t going to work,” Andrew Metrick, Director of the Yale  Program on Financial Stability, warned in a December 23 Yale Insights article.  Consequently, significant loan losses can be expected. 

Thus far, commercial real estate loans largely continue to perform because they still  have very low interest rates. And the drop in the valuation of the properties appears  certain. However, as these loans become due for refinance, the painful but slow  processing of commercial real estate losses could quickly turn urgent.

 

 

The Bill is Coming Due on a Record Amount of Commercial Real Estate Debt. More than $2.2 trillion in debt is maturing before 2028, and much of that will have to be refinanced at higher rates. (WSJ 1/16/24)

​

 

In 2016, the Financial Accounting Standards Board implemented Current Expected  Capital Losses          (CECL), a new accounting standard for how reserves should be  established for expected losses from existing loans. Consider all commercial real  estate loans that are approaching the time when they need to be refinanced. They  may have originated at 3% to 4% (or lower) while current rates are closer to 7% and property values are down significantly. In many cases, the issue will be how the  losses will be divided. With the newly adopted accounting rule, financial  institutions are required to determine what they believe the probability is of a loan  paying off in the future, even if it is presently current with its repayment terms.  However, to date financial institutions continue to revise and refine significant  provisioning for losses under CECL. Full and stabilized implementation of the new  accounting standard should accelerate the recognition of potential loan losses. 

 

Where to go for help.

 

I recently met with John Hancock and Marty Treece, two of the founders and principals of Gelde Advisors (www.gelde.co).  John is a highly experienced CPA and was a Partner and Financial Services Group Leader for Moss Adams LLP for nearly 30 years. At Moss Adams, he led a group of 135 accounting and consulting professionals serving more than 500 financial institutions ranging from de novo to over $20 billion in asset size. Marty, a former securities broker and investment banker, is a seasoned real estate developer with over 40 years’ experience in residential and commercial real estate investment properties with a particular skillset in managing complex entitlement and regulatory approval processes.

 

Gelde Advisors is no stranger to helping financial institutions with troubled CRE loans. During our recent meeting, both John and Marty emphasized that “Gelde assesses the optimal strategy for each troubled real estate loan before recommending or committing to a course of action. We assist lenders with distressed borrowers and problem credits, and facilitate the acquisition, transfer, or workout of troubled real estate secured loans.  Our solutions are timely, solutions-oriented, and cost-effective.”

​How Gelde Advisors Helps Resolve Troubled Commercial Real Estate Loans. “Gelde Advisors was established as an outlet to assist financial institutions reposition  loan portfolios primarily for commercial real estate loans that no longer meet  underwriting standards or are moving to troubled loan status. We do that through  the following process: 

•     We facilitate the disposition and sale of select troubled CRE loans for credit  unions – we do this subject to a standard NDA and engagement agreement,  and do not take an ownership interest in the specific asset. 

 

•    We establish with each lender a targeted “ask” price for loans that they wish  to resolve – following our due diligence, loans are placed on a secure,  proprietary platform and undergo a bidding process among thousands of  individual and institutional investors. 

 

•    We vet all bids and present those that are potentially acceptable to the selling  financial institution – typical number of bids have been double digit in prior  transactions with generally three presented for review and acceptance. 

 

•    We assist in completion of the sale and transfer of documentation from the  financial institution seller to the investing purchaser. 

 

•     We receive no compensation from any party unless the transaction is  completed – in this case, the purchasing party compensates our team but  never the selling financial institution.

 

 

Examiners will carefully consider all factors in evaluating a Credit Union’s efforts to provide relief for borrowers (NCUA Letter to Credit Unions January 24-CU-01)

 

How Gelde’s Services Help Financial Institution Borrowers.  For most borrowers, when a commercial real estate loan is recognized as troubled  or identified as troubled and being considered for refinance, their options are  limited. And alternatives for borrowers may become financially and operationally risky, if not unrealistic. Often at this time, borrowers need flexibility in terms and  rates that financial institutions cannot offer. Through the Gelde process, borrowers  will benefit from an alternate investor’s more flexible, beneficial loan terms such as  interest rate, maturity and loosening of covenants. New investors are often able to  work closely with borrowers in meeting their needs. Regulators typically don’t  afford financial institutions as much flexibility in working out their troubled  commercial real estate loans. 

How Gelde’s Services Help Financial Institutions.  Gelde believes in the old adage that “a credit loss, when first identified, represents  the least loss that will be recognized”. The aging of a troubled loan and delay in  action, can magnify loss potential. Gelde’s services avoid the need for excessive  internal collection costs, staff time, legal expenses, and costs for potential  foreclosure or receivership procedures that commit the financial institution to long term involvement. The Gelde solution is, therefore, a timely and cost-effective  option in the way a financial institution resolves its troubled commercial real estate  loans.”  

 

Gelde’s expert services include:

• LOAN RESTRUCTURINGS AND WORKOUTS. Gelde assesses the optimal strategy for each troubled real estate loan before recommending or committing to a course of action.  We assist lenders with distressed borrowers and problem credits, and facilitate the acquisition, transfer, or workout of troubled real estate secured loans.  Our solutions are timely, solutions-oriented and cost-effective.

• COMPREHENSIVE ASSET VALUATIONS. Gelde provides expert underwriting evaluations and up-front market value assessments of single assets and large pools of multiple member real estate loans.  We provide current valuations, and the anticipated value that may be anticipated in a successful resolution.

• LOAN SALES. The Gelde loan sale services were specifically designed to address the rapidly changing institution-to-investor loan sales market. Approaching loans as a true real estate asset, our active, hands-on approach helps achieve higher sales velocity, transparency, and maximum yield for both single asset and portfolio offerings.  Our investor base consists of more than 75,000 active individuals and organizations across the country.

• INTRODUCTION TO ALL-INCLUSIVE LEGAL SERVICES. Gelde’s industry-leading counsel connections can introduce all-inclusive services to address our clients' forbearance, foreclosure, restructure, receivership, deed-in-lieu, and trustee needs.   We are just as pleased to work collaboratively with legal counsel selected or appointed by our clients.

 

W. Martin (Marty) Treece

Principal

mtreecegelde.co

503.703.3930

John Hancock

Principal

jhancock@gelde.co

503.706.7002

The Next Step. For more information, please contact:

 

 

 

Or visit https://www.gelde.co

About CUinfluentialsm 

We're passionate about helping local businesses reach their full potential. In many cases, Credit Unions, Credit Union Service Organizations (CUSOs), Business Owners and Entrepreneurs are like ships passing in the night, missing opportunities to collaborate for mutual growth and success.

CUinfluentialsm is the solution.

​

We research and identify qualified small and medium-size businesses, as well as new and established Credit Union Service Organizations, that can serve the needs of Credit Union members, then introduce those businesses to Credit Unions, other Credit Union Service Organizations, key industry leaders and trade association resources, such as the National Association of Credit Union Service Organizations.

​

There are 140 million Credit Union members.  How many of them are your customers? Contact us today to learn more about how we can help you and your small or medium size business or CUSO grow and succeed by collaborating with Credit Unions and their members.

 

“Commercial Real Estate: Into the Headwinds”, Goldman Sachs Asset Management, June 29, 2023

“Commercial Real Estate Lending Trends in 2024”, Acquity Knowledge Partners 2924

NCUA Letter to Credit Unions No. 24-CU-01, January 2024