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‘Zombie Offices’ Spell Trouble for Some Banks

Graceful art-deco buildings towering above Chicago’s key business district report occupancy rates as low as 17 percent.

A set of gleaming office towers in Denver that were full of tenants and worth $176 million in 2013 now sit largely empty and were last appraised at just $82 million, according to data provided by Trepp, a research firm that tracks real estate loans. Even famous Los Angeles buildings are fetching roughly half their prepandemic prices.

From San Francisco to Washington, D.C., the story is the same. Office buildings remain stuck in a slow-burning crisis. Employees sent to work from home at the start of the pandemic have not fully returned, a situation that, combined with high interest rates, is wiping out value in a major class of commercial real estate. Prices on even higher-quality office properties have tumbled by 35 percent from their early 2022 peak, based on data from the real estate analytics firm Green Street.

Those forces have put the banks that hold a big chunk of America’s commercial real estate debt in the hot seat — and analysts and even regulators have said that the reckoning has yet to fully take hold. The question is not whether big losses are coming. It is whether they will prove to be a slow bleed or a panic-inducing wave.

The past week has brought a taste of the brewing problems when New York Community Bancorp’s stock plunged after the lender disclosed unexpected losses on real estate loans tied to both office and apartment buildings.

So far “the headlines have moved faster than the actual stress,” said Lonnie Hendry, chief product officer at Trepp. “Banks are sitting on a bunch of unrealized losses. If that slow leak gets exposed, it could get released very quickly.”

When a string of banks failed last spring — partly because of rising interest rates that had reduced the value of their assets — analysts fretted that commercial real estate could trigger a wider set of problems.

Banks hold about $1.4 trillion of the $2.6 trillion in commercial real estate loans set to mature over the next five years, based on data from Trepp, and small and regional lenders are especially active in the market.

Economists and regulators feared that heavy exposure to the dicey-looking industry might spook bank depositors, particularly those with savings above the $250,000 limit for government insurance, and prompt them to withdraw their funds.

But government officials responded forcefully to the 2023 upheaval. They helped sell off failing institutions, and the Federal Reserve set up a cheap bank funding option. The actions restored confidence, and bank jitters faded from view.

That has changed in recent days with the issues at New York Community Bancorp. Some analysts are dismissing it as a one-off. New York Community Bancorp absorbed the failing Signature Bank last spring, accelerating its troubles. And so far, depositors are not pulling their money out of banks in large numbers.

But others see the bank’s plight as a reminder that many lenders are in for pain, even if it doesn’t spur systemwide panic. The reprieve the government provided the banking system last year was temporary: The Fed’s funding program is set to shut down next month, for instance. Commercial real estate problems are lasting.

Commercial real estate is a wide asset class that includes retail, multifamily housing and factories. The sector as a whole has had a tumultuous few years, with office buildings hit especially hard.

About 14 percent of all commercial real estate loans and 44 percent of office loans are underwater — which means that the properties are worth less than the debt behind them — according to a recent National Bureau of Economic Research paper by Erica Xuewei Jiang from the University of Southern California, Tomasz Piskorski from Columbia Business School and two of their colleagues.

While huge lenders like J.P. Morgan and Bank of America have begun setting aside money to cover expected losses, analysts said that many small and medium banks are downplaying the potential cost.

Some offices are still officially occupied even with few workers in them — what Mr. Hendry called “zombies” — thanks to yearslong lease terms. That allows them to appear viable when they are not.

In other cases, banks are using short-term extensions rather than taking over struggling buildings or renewing now-unworkable leases — hoping that interest rates will come down, which would help lift property values, and that workers will return.

“If they can extend that loan and keep it performing, they can put off the day of reckoning,” said Harold Bordwin, a principal at the distressed real estate brokerage Keen-Summit Capital Partners.

Bank-reported delinquency rates have remained much lower, at just above 1 percent, than those on commercial real estate loans that trade in markets, which are over 6 percent. That’s a sign that lenders have been slow to acknowledge the building stress, said Mr. Piskorski, the Columbia economist.

But hopes for an office real estate turnaround are looking less realistic.

Return-to-office trends have stalled out. And while the Fed has signaled that it does not expect to raise interest rates above their current 5.25 to 5.5 percent level, officials have been clear that they are in no hurry to cut them.

Mr. Hendry expects that delinquencies could nearly double from their current rate to touch between 10 and 12 percent by the end of this year. And as the reckoning grinds on, hundreds of small and medium banks could be at risk.

The value of bank assets have taken a beating amid higher Fed rates, Mr. Piskorski and Ms. Jiang found in their paper, which means that mounting commercial real estate losses could leave many institutions in bad shape.

If that were to rattle uninsured depositors and prompt the sort of bank runs that toppled banks last March, many could plunge into outright failure.

“It’s a confidence game, and commercial real estate could be the trigger,” Mr. Piskorski said.

Their paper estimates that dozens to more than 300 banks could face such disaster. That might not be a crushing blow in a nation with 4,800 banks — especially because small and medium lenders are not as connected to the rest of the financial system as their larger counterparts. But a rapid collapse would risk a broader panic.

“There is a scenario where it spills over,” Mr. Piskorski said. “The more likely scenario is a slow bleed.”

Officials at the Fed and the Treasury Department have made it clear that they are closely monitoring both the banking sector and the commercial real estate market.

“Commercial real estate is an area that we’ve long been aware could create financial stability risks or losses in the banking system, and this is something that requires careful supervisory attention,” Treasury Secretary Janet L. Yellen said during congressional testimony this week.

Jerome H. Powell, the Fed chair, acknowledged during a “60 Minutes” interview aired on Feb. 4 that “there will be losses.” For big banks, Mr. Powell said, the risk is manageable. When it comes to regional banks, he said that the Fed was working with them to deal with expected fallout, and that some would need to close or merge.

“It feels like a problem we’ll be working on for years,” Mr. Powell admitted. He called the problem “sizable” but said that “it doesn’t appear to have the makings of the kind of crisis things that we’ve seen sometimes in the past, for example, with the global financial crisis.”

Alan Rappeport contributed reporting.

Sumber: www.nytimes.com