Banks Keep an Eye on CRE Loan Risk

At the highest level, conditions appear to be good in commercial real estate lending, and the Mortgage Bankers Association’s recent survey of CRE lenders found that most anticipate increased volume for 2022. However, in the banking sector, writes Trepp’s Matt Anderson, “COVID’s impacts can still be seen. Delinquency rates are still elevated for lodging and retail, the property-type mix within originations has clearly shifted to the pandemic favorites (industrial and multifamily) and lenders are still casting a wary eye on urban office markets.” 

CRE mortgage delinquencies among bank loans hit a recent peak of 1.3% in the fourth quarter of 2020, as the pandemic disrupted economic activity across a broad range of geographies and industries. As of Q3 2021, the overall CRE delinquency rate stood at just under 1%, while the noncurrent (more serious delinquencies) rate stood at 0.8%. Both are still above their pre-pandemic levels.  

Delinquency rates for both lodging and retail – 11.9% and 4.9%, respectively – edged up slightly in Q2 2021, after showing noticeable improvement in Q1. “The uptick in Q2 is a reminder that the path to recovery may be protracted over a longer period,” Anderson writes. 

Short of actually sliding into delinquency, a loan may be ‘criticized”–assigned a risk rating of 6 or higher on a scale of 1 to 9. Anderson writes that banks began re-assessing the risks they assigned to CRE loans almost immediately upon the onset of the pandemic late in Q1 of 2020. 

Nearly two years later, “lenders in the Mid-Atlantic have elevated concerns about risk across all three of the largest property types,” writes Anderson. “More than 30% of loans – by loan balance – in the multifamily, office and retail property types carry risk ratings of 6 or higher.” 

Risk ratings for office loans have increased, especially in the largest markets, due to the uncertain long-term prospects for the sector. The “large and commuter-dependent” New York office market is the source of the Mid-Atlantic’s high 31% proportion of criticized loans, Anderson writes. The other large metro areas with large CBD office markets – such as Boston and Chicago – are also driving double-digit proportions of criticized loans in the New England and East North Central areas.  

Although multifamily generally has a low proportion of criticized loans, lenders in several regions were keeping a closer eye on multifamily as of Q3 2021. “A slew of income and renter protections that were put in place in response to the pandemic and its disruption to the economy were set to expire in the third quarter,” Anderson notes. 

Longer term, the prospect of prolonged inflation may not be such a bad thing from the standpoint of CRE loan risk. “Inflation should lead to higher rents and higher real estate valuations,” writes Anderson. “With higher income and higher values, existing loans will see DSCRs increase and LTVs decrease, which will make today’s loan portfolios look less risky in the future.”