Is a Bank Bailout in Our Future? A Reckoning for CRE Debt

What you'll learn in this article:

• The commercial real estate market faces a crisis with $900 billion in loans maturing by the end of 2024.
• Smaller banks are highly vulnerable, holding 56.1% of all commercial property loans.
• "Systemic weakness" in banks has led to downgrades, with 282 U.S. banks at risk due to CRE debt.
• Growing instability may lead to a widespread bank bailout as pressures mount.

The commercial real estate market is facing a critical juncture as approximately $900 billion worth of real estate loans and securities, primarily issued at rates much lower than current ones, are set to mature by the end of 2024.

This impending wave of debt repayment and refinancing is compounded by a landscape of rising interest rates and persistent inflation, which remains above the Federal Reserve's target. So, we don’t even want to say this out loud, but that means even higher rates could be in our future.

And as building owners continue to grapple with the dual pressures of depreciating asset values and escalating borrowing costs, the financial stability of banks heavily exposed to commercial real estate is becoming a house of cards precariously stacked on trillions of dollars in debt. So, it’s no wonder that the question on everyone’s mind is: Are we on the brink of a bank bailout? Let’s discuss.

And massive waves of debt are only a singular effect of a post-COVID, apocalyptic office environment. So, get the full picture on how the evolving situation affects corporate tenants. Download your free copy of Surviving the Office Apocalypse today.

Trouble Brewing for U.S. Banks

Trouble is looming for banks due to a confluence of declining commercial property values and the substantial amount of commercial real estate (CRE) debt nearing maturity.

This significant drop in property values undermines the collateral backing CRE loans, increasing the risk of loan defaults and complicating the refinancing process.

Further exacerbating the situation is the prevalence of non-recourse loans in commercial real estate. These loans allow landlords to default without additional financial obligation beyond the property itself, effectively passing the financial buck onto the banks. And let’s just say, there’s a lot of bucks being passed on.

So to say the stakes are high is an understatement. There is nearly a $6 trillion problem and a considerable portion of this debt is tied to smaller banks, which are more vulnerable due to their disproportionate exposure to CRE loans.

Simultaneously, property valuations continue to decline amidst a hybrid-friendly working world, and banks face mounting challenges in refinancing the maturing debt. Lower property values mean new loans may not cover the outstanding balance of old loans, leading to potential shortfalls.

Hurt Concentrated in Smaller Banks

Smaller U.S. banks, in particular, are at heightened risk, holding 56.1% of all commercial property loans. This high exposure makes them especially susceptible to the risks associated with declining property values and increased defaults, raising the possibility of bank failures if credit losses accelerate.

Compounding these issues is, of course, the threat of rising interest rates. With inflation running at double the Federal Reserve's target, there is a significant risk that interest rates could climb even higher. Higher borrowing costs will add another layer of difficulty for property owners needing to refinance their loans.

Analysis by the Klaros Group underscores the gravity of the situation, finding that 282 out of 4,000 U.S. banks face the dual threat of CRE loans and potential losses tied to higher interest rates.

A closer examination reveals that 67 banks, each with more than $10 billion in assets, have CRE exposure exceeding 300% of their total equity. This level of exposure is deemed excessive by the Federal Reserve, thereby heightening the risk of bank failures.

More broadly, over 1,800 banks have CRE exposure greater than 300%, with a significant number of these banks having exposure levels exceeding 400%, 500%, and even 600%. For comparison, the industry average for CRE loan exposure is 139% of total equity.

“Systemic Weakness”

The "systemic weakness" in the banking sector, driven by significant exposure to commercial real estate (CRE) loans, is leading to downgrades in banks' ratings. Moody’s Ratings has announced that at least six U.S. regional banks are at risk of having their debt ratings downgraded. These banks include First Merchants Corp., F.N.B. Corp., Fulton Financial Corp., Old National Bancorp, Peapack-Gladstone Financial Corp., and WaFd.

And such downgrades are likely to become more common. This is especially true considering how widespread the issue is in the banking sector. We’re already starting to see the damn breaking. In 2023, the United States experienced the highest number of bank closings since 2008.

And if we look at last year, we see big names in the industry starting to sweat and take real action to prevent any massive disruption.

Amid issues, a joint force comprised of the 11 largest banks in the country, Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs Morgan Stanley, BNY-Mellon, PNC Bank, State Street, Trust and U.S. Bank, pooled resources to avoid a catastrophic scenario. Each put in from $1 billion to $5 billion to total a $30 billion deposit to avoid the possibility of a bank run and support any withdrawals of deposits.  

Is a Widespread Bank Bailout Coming?

While everyone will continue to wait and watch what happens, what’s certain is that: as interest rates remain elevated, the economic risks continue to multiply, increasing the likelihood of a recession.

And we’re about to see the issue reach a new threshold of pressure now that 500 million additional square feet of net rentable area (NRA) in office and mixed-use properties backed by commercial mortgage-backed securities (CMBS) are expiring over the next five years.

This impending wave of debt maturities, combined with falling property values and rising refinancing costs, exacerbates the financial instability within the banking sector.

The vulnerabilities of banks heavily exposed to commercial real estate are becoming more pronounced, leading to rating downgrades and potential bank failures. The confluence of these factors not only threatens the stability of individual banks but also poses a systemic risk to the broader financial system. As we navigate these uncertain times, the need for vigilant risk management and potential policy interventions becomes increasingly critical to mitigate the cascading effects on the economy.

So it’s every man for himself. And the time has never been more important for corporate tenants to safeguard their interests. There is a minefield of landlord defaults and receivership everywhere for tenants to beware. Modern office leases need to evolve to consider this unprecedented, dangerous environment. Because if you’re not careful, it’s only a matter of time before your commercial real estate portfolio is tangled up in a complicated web of debt, ownership, and dropping services. 

Download your free copy of Surviving the Office Apocalypse to receive invaluable insight straight from the experience of the True Tenant Representatives™..