The Federal Reserve Bank of New York today released a report highlighting how banks modify the terms of commercial real estate (CRE) loans to hide potential losses, posing risks to the financial system. The CRE sector has struggled since the pandemic due to reduced demand for office space due to remote working and lockdowns. Despite these challenges, the sector has yet to show signs of significant recovery.
The report notes that starting in spring 2022, banks have adopted a practice known as “stretch-and-fake,” which extends the term of impaired CRE mortgages to avoid principal write-downs. . This led to misallocation of credit and increased financial vulnerability. The study authors warned that problems associated with this type of loan can arise suddenly.
Fed officials expect that there will be some manageable difficulties among banks with CRE loans, and that any problems will be minor, primarily impacting smaller entities, and will gradually increase. I hope that it will develop. However, there has been no major turmoil in the overall market so far, with non-performing loans and net charge-offs remaining at low levels, especially among banks with low capital strength.
Banks hold the lion’s share of the $5.8 trillion CRE loan market, accounting for 50.7% of these loans in the final quarter of 2023. The report shows that companies with low capital levels are more likely to extend their loan terms due to losses on their securities holdings. . These extensions could make it difficult to issue new CRE loans and create a “maturity wall” where a large number of loans could mature at the same time, potentially leading to large losses. is increasing.
The study found that CRE mortgages from poorly capitalized banks were slightly more likely to have their terms extended compared to mortgages from well-capitalized institutions. However, the Fed’s rate cuts that began in September are expected to continue, potentially providing some relief to the CRE loan market.
In related news, Moody’s (NYSE:) on Monday upgraded its outlook for the banking sector to stable, attributing this to stabilizing asset quality, particularly from lower rates on CRE loans. Additionally, a late September report from Goldman Sachs (NYSE:) noted that while the pace of CRE loan market expansion has slowed, there is little evidence of a credit crisis in the sector.
Reuters contributed to this article.
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