CRE Loan Re-Defaults Hit Decade-High Levels
The classic saying, “If at first you don’t succeed, try again,” can be admirable in many situations. However, when it comes to commercial real estate (CRE) loans that borrowers struggle to refinance, the consequences can be more complex. As noted by the *Financial Times*, this approach has contributed to a significant rise in “double defaults,” with re-defaults soaring by 90% in 2024 compared to the previous year.
As loans near maturity or face missed payments, banks have leaned on what some call the “extend-and-pretend” strategy, or “delay-and-pray” for the more skeptical. This approach involves modifying loans, extending their terms, and hoping that the Federal Reserve will lower interest rates enough for borrowers to refinance before the situation worsens—essentially hoping to kick the problem down the road without affecting the bank’s balance sheet.
Loan modifications have surged in 2024, setting the stage for a record year in terms of total modifications. In 2023, banks modified $16.8 billion in loans, with an average monthly volume of $1.8 billion. April saw the peak, with $3 billion in modifications. By May 2024, the total reached around $22 billion, and $9 billion worth of loans had been modified just in that year alone.
However, this approach carries risks. A borrower who defaults, receives a loan extension or other relief, and later defaults again creates a cycle that increases the potential for financial instability. According to *Financial Times* analysis, data from BankRegData shows that the number of CRE borrowers receiving relief and subsequently becoming delinquent again is at its highest level since 2014.
The “extend-and-pretend” strategy has been criticized before. Following the 2008 financial crisis, many argued that the approach only delayed the inevitable. More recently, a study by the New York Federal Reserve cautioned that banks’ use of this strategy post-pandemic—particularly in CRE—has led to credit misallocation and increased financial fragility. By postponing necessary adjustments, the strategy has also crowded out new credit, causing a 4.8%–5.3% drop in CRE mortgage originations since the first quarter of 2022, and contributing to the looming “maturity wall,” which as of late 2023, accounts for 27% of bank capital.
Despite rising delinquencies, banks have been slow to offer substantive relief. According to Moody’s, banks have been reluctant to offer significant payment breaks, allowing borrowers only to delay missed payments. This has led to the impression that banks are simply “kicking the can down the road,” as Ivan Cilik, a principal at accounting firm Baker Tilly, put it. While banks are attempting to manage these troubled loans, Cilik emphasized that if interest rates don’t decrease, many borrowers will remain unable to meet their payment obligations.
“We are still in the early stages,” Cilik warned. “If delinquencies continue to rise, it will become clear that these loan modifications are not having the desired effect.”
Federal Reserve Chairman Jerome Powell has made it clear that there is no rush to reduce interest rates. In the press conference following the Federal Open Market Committee’s latest meeting, Powell signaled that there is no immediate plan to lower rates, meaning that relief for struggling borrowers may not come as soon as some had hoped.
Source: GlobeSt.
