Major Banks Are Stealthily Beginning To Offload Troubled Commercial Loans

Some of Wall Street's biggest commercial lenders have stealthily begun selling off their delinquent commercial loans. Although these moves play quietly behind the scenes and don't include entire portfolios, they may indicate a growing fear that some delinquent commercial loans won't be repaid because the office market may never recover. At a minimum, it would appear as if these big banks are taking steps to protect themselves from the worst-case scenario.

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Since the end of the pandemic, the commercial industry has been a source of concern for economists and mortgage lenders. Office spaces that had been fully leased out were suddenly vacant because the rise of remote work shrunk demand. According to CommercialEdge's National Office report, the nationwide occupancy rate in America's commercial market is just over 80%, which is a disaster considering that commercial properties need to be above 90% occupied to make money. 

Vacant office buildings don't make mortgage payments either. The amount of commercial debt on the books is large enough that some economists believe it could cause a major meltdown of the economy. Still, a recent stress test of America's biggest banks reveals that risk is comparatively small. Despite that, the Mortgage Bankers Association estimates that almost $1 trillion in commercial loans will mature in 2024 alone.

Knowing this, some of America's largest commercial lenders proactively sell troubled loans. The New York Times reports that Deutsche Bank, Goldman Sachs, and Canada-based lender CIBC have sold mortgages and tranches from mortgage portfolios worth hundreds of millions of dollars since late 2023. Although they will likely take a loss by selling the mortgages for less than the loan amount, selling the loans now allows them to reduce their risk.

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Once a loan goes into default, the mortgage lender's only recourse is to sell the underlying asset. However, a mortgage lender is almost guaranteed to take a larger loss on a distressed asset sale than they would by selling a delinquent loan before it defaults. This process could have been avoided in years past by allowing borrowers to refinance the loans.

Unfortunately, today's elevated interest rates make refinancing a financial disaster for building owners. Up to now, many banks have responded with a strategy that has come to be known as "pretend and extend," where banks extend the borrower's current terms rather than call in the loan. Theoretically, this gives the borrower time to boost occupancy and get the loan current, despite both sides knowing that's almost impossible in today's market.

That's where the "pretend" element comes in. A strategy based on that kind of wishful thinking is unsustainable, and the latest moves by big banks to begin shedding some of their bad loans may be evidence of a course correction. Rather than extending and pretending, some of these banks appear to be taking smaller losses by selling delinquent loans before a glut of bad loans and toxic assets hit the market simultaneously.

Jay Neveloff, head of the real estate practice for law firm Kramer Levin, told the New York Times, "The banks know they have too many loans on their books." Neveloff believes this is spurring banks to contact his clients, offering to sell loans at a discount. He told the Times he's working on several deals as a representative for private buyers contacted by big banks looking to sell. 

At the same time, the banks want to avoid the appearance of a fire sale, even while they quietly offload at-risk loans. Neveloff said, "The banks are going to a select number of brokers, saying, ‘I don't want this public.'" It appears all parties involved in these transactions are walking a fine line between protecting their self-interest and avoiding a market panic. Only time will tell how successful that strategy is.

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