How Banks Are Addressing Cre Risks

Commercial Real Estate has faced a double-barrel of headwinds coming from 1) higher rates, and 2) the work-from-home craze. Now it faces a 3rd headwind: increasing delinquencies, which of course can lead to increased defaults. But it's not that easy to see. Banks have been employing the tricks of their trade to avoid disclosing the scale and scope of the credit challenge they face. How do I know this? TDRs are going ballistic right now. TDR stands for "Troubled Debt Restructurings", also known as Loan Modifications, or Loan Mods. What happens with a TDR is the bank works out a deal with the borrower to adjust the monthly payment down, usually by offering one of 3 things: 1) a term extension, or 2) a lower rate, or 3) both. It's good for the commercial borrower because they get a more affordable payment. It's good for the bank because they can avoid reporting the loan as non-accruing or non-performing. These TDRs can continue to accrue interest. A Non-Performing Loan (NPL) no longer accrues interest. I saw some data recently on BankRegData.com which synthesizes Call Report data. The graph shows that as of Q3 2024, $9B of Non-Owner Occupied (NOO) CRE had been modified, up from only $1.3B as of Q1 2023. That's a 577% increase in modified loans, which makes up 0.77% of all NOO CRE in the US. Total NPLs in NOO CRE were 1.80% of loans as of Q3 2024, which is up from 0.54% in 2022 - a 233% increase in NPLs. But if you add all those TDRs in there, NPLs would be 2.57% of total loans. I think that from a credit standpoint it is reasonable to factor in this increase in the rate of TDRs, and comparing that to the NPL rate, when considering the credit quality of banks. If interest rates are going to stay higher for longer, it will get harder for banks to cover up this CRE problem with restructured loans. #fedpolicy #interestrates #riskmanagement

The NY Fed published this white paper “Extend-and-Pretend in the U.S. CRE Market”, which analyzes how banks have managed their exposure to distressed commercial real estate (CRE) loans in the post-pandemic period. Key findings include: 1) Extend-and-Pretend Behavior: Banks, particularly those with weaker capital positions, have extended the maturity of impaired CRE loans to avoid realizing losses, a practice known as “extend-and-pretend.” This has delayed the recognition of losses, preventing write-offs that could impact banks’ capital. 2) Impact on Credit Allocation: The study finds that this behavior has led to a decrease in new CRE loan originations, with an estimated drop of 4.8–5.3% since early 2022. This “credit misallocation” has hindered the adjustment of the CRE market to new post-pandemic realities, like shifts in office demand due to remote work. 3) Maturity Wall: The extensions have resulted in a “maturity wall,” where a significant volume of CRE loans is set to mature soon. As of late 2023, this volume is estimated to represent 27% of banks’ capital, posing risks if many loans default simultaneously. 4) Focus on Bank Capitalization: The analysis shows that undercapitalized banks, facing large unrealized losses from higher interest rates, were more likely to engage in extending maturities of distressed loans. This strategic behavior was aimed at maintaining regulatory capital levels despite rising risks in the CRE market. . . . . #nyfed #extendandpretend #cre #crefinance #maturity #gsp #axcspace #nyc

🔍 Ever Wondered How Banks Manage Their Capital and Risks with Basel III? 📊 Understanding the Bank’s Capital Ratio: The Bank's Capital Ratio is a key metric in Basel III that ensures banks have enough capital to cover potential losses. This ratio is calculated by taking Total Capital (which is the bank’s financial buffer) and dividing it by various risks that the bank faces. The goal? To ensure banks have enough capital to operate safely and absorb shocks during tough economic times. The higher the Capital Ratio, the safer the bank. 1️⃣ Credit Risk: This represents the risk of default by borrowers. Banks need to hold capital against potential losses if customers fail to repay their loans. 2️⃣ Market Risk VaR (GMR + SR): VaR (Value at Risk) measures the potential loss in the bank's portfolio due to market fluctuations. GMR refers to General Market Risk, while SR refers to Specific Risk (like the risk associated with a specific asset or sector). 3️⃣ Stressed VaR: This is VaR under extreme market conditions, like financial crises, to ensure banks can handle even the most severe market shocks. 4️⃣ Operational Risk: This accounts for potential losses due to failed internal processes, human errors, or system breakdowns—basically, any operational hiccup that could lead to financial loss. 5️⃣ IRC (Incremental Risk Charge): This additional charge is meant to cover the risk of default and credit migration for trading positions that are exposed to market risk. 6️⃣ Securitization Framework: Banks must also hold capital against risks tied to securitized assets (like mortgage-backed securities). This ensures that risks from bundled assets are properly accounted for. 7️⃣ CRM (Credit Risk Mitigation): These are techniques banks use to reduce the risk of credit loss, such as collateral, guarantees, or hedging. Banks can adjust their capital needs based on the level of risk mitigated. 8️⃣ CVA (Credit Valuation Adjustment): This refers to the risk of a counterparty defaulting before fulfilling its obligation on a derivative transaction, impacting the derivative’s market value. Banks need to reserve capital against this risk. 9️⃣ Liquidity and Leverage Ratios: Liquidity Ratios ensure banks have enough liquid assets to meet short-term obligations, while Leverage Ratios prevent banks from taking on too much debt relative to their capital. 🏦 The Pillars of Basel III: Pillar I: Ensures banks maintain minimum capital and liquidity requirements. Pillar II: Strengthens risk management practices through supervision and firm-wide risk assessment. Pillar III: Promotes transparency and market discipline by enhancing risk disclosure. #BaselIII #RiskManagement #Banking #Finance #LiquidityRisk #OperationalRisk #MarketRisk #CreditRisk #FinancialStability #CapitalRequirements #QuantFinance #FinancialRegulation