Banks Face a $2 Trillion Commercial Real Estate Debt Maturity Wall. What Should They Do Next?

Assessing the CRE debt risk facing today’s US banks—and how to mitigate it

When it comes to commercial real estate (CRE), doomsayers are out in force: $2 trillion in debt will be coming due in the US over the next three years, according to some estimates, as interest rates, insurance premiums, and labor costs remain high and assets struggle in the post-pandemic world. In Manhattan alone, the delinquency rate for loans on office buildings jumped more than 1,000 percent from January 2023 to January 2024.

Bank lenders already strained by shrinking deposits may be left holding the bag, as CRE loans can comprise a significant chunk of their balance sheets. In March, for example, S&P Global downgraded the outlooks for five US banks over such exposure, while the Federal Deposit Insurance Corporation (FDIC) noted that the noncurrent rate for nonowner occupied CRE loans (1.59 percent) is at its highest level since Q4 2013. As a result, some banks are “quietly dumping real estate loans,” indicating that the “extend and pretend” strategy—41 percent of loans maturing in 2023 were modified or extended—may be losing steam as defaults become inevitable.

But is the impending debt wall really that grave? Which banks may be more vulnerable? And what can bank leaders do to mitigate potential risks?

Assessing the Severity of the Debt Maturity Wall on US Banks

The current debt wall has drawn comparisons to the 2008 crisis. But is the correlation accurate? What are the key differences, and how do they apply to your institution? Below I unpack some key claims to help executives make informed decisions.

The CRE sector is facing a significant wall of debt

Now: Vacancy rates are rising in both the office and multifamily sectors. The former is due in large part to the popularity of remote work, while the latter may stem from overbuilding in some markets. Regardless, these CRE loans will mature or expire soon, and refinancing could be difficult amid high interest rates, lower property values, and rent growth pressures.

Then: We are likely in better shape than in 2008, when the crisis was largely the result of defaults in residential markets. As an April 2023 Moody’s analysis notes, “CRE loans have less leverage, asset pricing has more cushion, and borrowers have a more diverse set of debt sources” than during the global financial crisis. What’s more, the banking industry reported in June that just under $37 billion in CRE loans, or 1.17 percent of all loans held by banks, were delinquent; in the wake of the 2008 crisis, these delinquencies hit 9 percent by 2010.

Small, regional, and community banks are overexposed to the CRE market

Now: US community and regional banks are almost five times more exposed to the CRE sector than big banks—with the largest total direct CRE exposure falling on those with $1 billion to $10 billion in assets. Another report, cited by Reuters, found that CRE holdings comprise 13 percent of large US banks’ balance sheets and 44 percent of regional ones. These issues come in the wake of 2023’s bank failures, which included several notable collapses of smaller institutions due to overexposure in certain areas.

Then: Banks are better capitalized now than they were before the financial crisis, largely as a result of tighter lending standards. And as Moody’s writes, they also “have access to a wider array of credit facilities meant to backstop temporary liquidity issues and stem contagion.”

For instance, numerous regional and community banks are exploring deals with private investors and lenders ready to buy existing loans at a discount. Banks have also seen deposits stabilize in recent months and have had the ability to take advantage of new tools, like the Federal Reserve’s Bank Term Funding Program, to proactively increase liquidity buffers. Finally, Moody’s data suggests that CRE exposure may not be as significant as some say: regional banks, for instance, hold just 13.8 percent of debt on income-producing properties.

Overall Share of Banks’ Assets Exposed to CRE Loans

Source: Kevin Fagon et al., “What’s the Real Situation with CRE and Banks: Doom Loop or Headline Hype?” Moody’s (April 4, 2023). https://cre.moodysanalytics.com/insights/cre-news/whats-the-real-situation-with-cre-and-banks-doom-loop-or-headline-hype/

Large banks have less to worry about

Now: As the figure above shows, large banks’ total CRE exposure is only 6.8 percent. This makes sense given that these institutions tend to be more diversified than their smaller counterparts. Yet a new study argues that big banks’ CRE exposure increases by 40 percent when including indirect lending to real estate investment trusts (REITs).

Then: The analysis found that large US banks had $345 billion of indirect exposure to commercial real estate in the fourth quarter of 2022, compared to $109 billion in the same period nine years earlier. Worse, REITs are relatively cash poor given their annual dividend obligations, meaning they may draw down credit from lenders in moments of economic volatility—creating a “sudden encumbrance of capital and/or liquidity.”

Best Practices for Banks Navigating CRE Risk

No matter where your bank sits in the CRE ecosystem, it’s worth assessing your exposure and taking steps to mitigate potential risks.

From a regulatory perspective, the FDIC released guidance that advises banks with significant CRE concentrations to:

• maintain strong capital levels
• ensure that credit loss allowances are appropriate
• manage construction and development and CRE loan portfolios closely
• maintain updated financial and analytical information
• bolster loan workout infrastructure
• maintain adequate liquidity and diverse funding sources

With that said, history has taught us that the top reason for a bank to become stressed and even fail is overconcentration in certain assets or liabilities. With Silicon Valley Bank, that overconcentration was in fixed investment securities funded by short-duration deposits, which made the bank susceptible to significant losses as interest rates rose. We have also seen overconcentrations in fixed-rate loans or geographic areas or industries.

Today’s crisis is no different, and banks (and their customers) need to understand at a granular level how exposed they are to CRE risks. Here are some fundamentals for stakeholders to keep in mind:

1. Update your “stress” testing. Stress tests are critical to maintaining liquidity and evaluating loan concentrations. A good stress test will evaluate how and at what point the bank will become at risk of failure. The objective is to understand what level of stress (in the case of CRE loans, this would be the level of defaults) the bank can absorb. These tests should focus on both capital and liquidity stressing.
2. Evaluate and operationalize your options. Once you’ve run your stress tests, consider the options. These should be part of loss-mitigation strategy and reflected in an updated liquidity funding plan.

   For instance, to the extent you are overconcentrated, what loss mitigation options are available? Can you refinance or syndicate certain CRE loans? Try a risk-transfer deal? Are the losses you might accrue as the result of selling these loans at a discounted rate worth the gain of getting it off your books? If a stress scenario occurred, could you execute on it? Are there options that need to be executed in stress scenarios? If so, have they been proven out and operationalized? Can you access the Federal Reserve’s discount window and place collateral if needed?Looking ahead to the rest of 2024, will you continue loaning to CRE borrowers?

3. Act now, not later. A lesson from recent history: just because something hasn’t happened before doesn’t mean it won’t happen. Do your analysis now, because the options and deals available will be better today than if the market goes further south.

   The themes undergirding today’s CRE market are unprecedented—but it’s not unprecedented that a bank could be at risk due to certain loan concentrations. Though the maturity wall may not hit everyone equally—and conditions may not be as bad as they were in 2008—it’s important to undertake a proactive risk analysis today, before it’s too late.