Are CRE foreclosures on the horizon?

Almost a year after the pandemic began, big questions are emerging about the future of commercial real estate portfolios.

Namely, how long can banks offer deferral of loans that have turned sour during the pandemic recession, are foreclosures inevitable, and how fast could foreclosure rates rise if the cone opens?

Bankers who have taken a largely reassuring tone about their ability to manage credit risk are likely to face such questions starting Friday when JPMorgan Chase, Citigroup and other major banks begin reporting fourth quarter results. However, they may give more non-answers than answers as the economic outlook remains blurry at best.

The US real estate market outlook for 2021, compiled by the CBRE Group, predicts that "real estate conditions will start to move in 2021" as some sectors "grow strongly" while others will continue to struggle. The lack of clarity in asset pricing won't help, said Richard Barkham, CBRE Global's chief economist.

"Banks will weaken and weaken until they see the value of the underlying asset and then they could foreclose because then they can crystallize their losses," he said. "We believe 2021 will be a pretty strong year for economic growth … but if we go around the corner and discover prices [happen], more banks are likely to see foreclosure," especially in hotel and retail loans.

Although commercial real estate has fared better than expected overall since the pandemic upset the U.S. economy, the sector has become increasingly distressed. The latest research by the Federal Reserve shows that 1% of all commercial real estate loans were in default as of September 30, up from 0.68% at the end of 2019.

However, the most recent percentage is well below that of all home loans, which had arrears at 1.92% at the end of the third quarter. However, it is the first time in five years that the interest rate on commercial real estate loans has hit the 1% mark.

Bankers say they closely and regularly monitor their commercial loan portfolios. They have also had more leeway to offer postponement and forbearance programs under the Coronavirus Law on Aid, Aid and Economic Security, while building massive reserves to cover losses.

Brian Foran, an analyst at Autonomous Research who deals with regional banks, said the circumstances of the macro environment made it nearly impossible for bankers to predict how bad portfolios might get and when. The nationwide rollout of coronavirus vaccines is behind schedule. The latest employment report found that 140,000 jobs were lost in December. This was the first net decline in payroll since the spring.

"I think they'll be optimistic from the point of view," Look, we have a lot of reserves built in 2020 so we have a cushion but we still don't know, "Foran said when asked what bankers were saying along the way could be calling for fourth quarter results. "Unfortunately, there isn't much clarity that they can give."

At an industry conference in December, William Demchak, Chairman and CEO of PNC Financial Services Group, said the company's criticized Pittsburgh real estate values ​​- "Think hotels, think retail" – are "not getting better, but worse" while “Office space will have problems”, depending on the location. Meanwhile, multi-family loans have "performed pretty well," but "massive rental losses" in metropolitan areas like New York City and San Francisco will "have an impact," he said.

At the same conference, Darren King, CFO of M&T Bank in Buffalo, New York, said that some of the bank's commercial real estate borrowers who asked for indulgence had returned to making regular payments. However, some CRE loans could be classified as problematic restructurings or non-accrual, he said.

"We feel positive about what we see, but we also realize we have a long way to go," said King.

This week, Bharat Masrani, president and CEO of Toronto-Dominion Bank, which operates a US subsidiary with assets of $ 420 billion, was similarly upbeat during a separate industry conference. He expects that TD's commercial real estate risks, which are mainly located in large metropolitan areas with mostly first-class real estate, will be “manageable” in the long term.

"And we're well cautious should the situation turn out to be very different from what we expected," he added.

Jennifer Demba, an analyst at Truist Securities, said the bank management teams tell her they don't expect "real [commercial real estate] losses" until mid-2021. But persistent hiccups in vaccine rollouts will continue to weigh on commercial real estate lending, she said.

"What is the demand for the vaccine, how quickly can it be introduced, and how can it be more effective?" Said Demba. “The stock exchange is calculating for normalization in the second half of the year. If [the rollout] doesn't improve, it could be the fourth quarter or 2022. I think that's the biggest wild card to be honest. "

By Tuesday morning, 9.3 million people had received their first dose of vaccine, according to the Centers for Disease Control and Prevention. The Trump administration, which wanted to vaccinate 20 million people by the end of 2020, changed its strategy Tuesday, saying it would release all vaccines rather than withhold some for the required second dosage.

Foran said the banks are currently in a "gray area" of credit uncertainty. Do people go back to the office or do they continue to work at home? Do you want to go shopping in the store again? Are they going to eat out and stay in hotels and travel for business?

"These are different versions of the same question: was the pandemic a temporary hiatus or a permanent change?" Foran said. “These are the known unknowns for banks. Some things are normalizing again, others are constantly changing, and we could make an educated guess [what will happen in each area], but ultimately we won't know until we're done with it. "

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