Title: Banks with Commercial Real Estate Lending Portfolios Feel the
Pinch

Description: Banks that loaned money for commercial real estate ventures
may be feeling the pinch, as many offices and business spaces continue
to sit vacant in the wake of COVID-19. A period of rising interest rates
has added to these concerns. We talk to GAO's Mike Clements about trends
in commercial real estate lending. 

Related work: GAO-24-107282, Commercial Real Estate: Trends, Risks, and
Federal Monitoring Efforts 

Released: September 2024

{Music}

[Michael Clements:] It's imperative that the regulators continue to
monitor this and ensure that cracks don't evolve that could affect the
entire financial system.

[Holly Hobbs:] Hi and welcome to GAO's Watchdog Report, your source for
fact-based, nonpartisan news and information from the U.S. Government
Accountability Office. I'm your host, Holly Hobbs. 
Banks that loaned money for commercial real estate ventures may be
feeling the pinch, as many offices spaces continue to sit vacant in the
wake of COVID-19. A period of rising interest rates has added to these
concerns about the amount of outstanding commercial real estate debt
held by banks--a dollar amount that has doubled over the last 10 years or
so. For a new report, we looked at this trend and how federal regulators
are responding to escalating concerns. We'll learn more from GAO's Mike
Clements, an expert in banking and financial markets. Thanks for joining
us.

[Michael Clements:] Happy to be here.

[Holly Hobbs:] So, Mike, how big of an issue is this? 

[Michael Clements:] Maybe for our listeners we want to talk about what
is commercial real estate. Right. So you've talked about office space,
but there's a variety of flavors of commercial real estate--offices,
retail, multifamily housing, apartments and also industrial. And it's
the fourth largest asset class in the United States. So very important
segment. You referenced debt, $6 trillion of debt outstanding on
commercial real estate. Of that, $3 trillion is held by banks and
another $1.5 trillion is held by other parts of the financial services
sector. So very important and timely concerns about the segment of the
industry. Unlike the financial crisis in 2007-2009, however, performance
is very variable. So, if we think about these various flavors of
commercial real estate, industrial is much different than offices, even
within offices--lot of variability there.

[Holly Hobbs:] So what are banks doing in response to this risk? Are
they working with borrowers so they don't default? What are they doing?

[Michael Clements:] Banks are doing a couple of things to respond to the
problems with commercial real estate. As you mentioned, they are working
with their borrowers--in many instances, extending those mortgages rather
than requiring the building owner to immediately repay that. That's
important because commercial real estate prices have fallen, especially
in the office segment and second that interest rates have increased. So
therefore, it would be difficult for some of these borrowers to repay
their funds. Secondly, what they're doing is for new loans, is they're
cutting back on the level of financing available. For example, the
Federal Reserve does a survey of senior loan officers. And it's
consistently found that 40% or more of those loan officers are
tightening lending standards for commercial real estate.

[Holly Hobbs:] We have seen, recently, fluctuations in interest rates.
But many of these loans were made before that. So why do we care about
interest rates now?

[Michael Clements:] We need to contrast a loan for a commercial real
estate with what our listeners might think of as a traditional mortgage,
right? A traditional mortgage is 30 years--some of them are 15 years, but
typically longer term. They're fully amortized. Each of your payments is
repaying part of the principal. Commercial real estate much different.
The loans are going to be shorter term, at most 10 years. They also have
a balloon payment--all the payment comes due at the end. And so what
typically happens is these commercial real estate owners will simply
refinance a loan at the end. They never pay the loan off. Unlike a
mortgage. That creates a challenge, right? We've just talked about that
banks are pulling back on some funding. It could be harder to get a loan
to repay the loan that you are currently outstanding. And second of all,
again the interest rates are higher. That means the cost of financing
the building is going to be more.

[Holly Hobbs:] So we've talked about the borrowers. We've talked about
the lenders. What about the regulators? What's their role in all of
this?

[Michael Clements:] So the regulators in this case it's the Federal
Reserve, FDIC and also the Office of the Comptroller of the Currency.
They supervise banks. And they do that in a couple of manners. First
off, they're going to conduct onsite examinations where they're in
looking at the books, talking the bank managers to understand what's
going on. Secondly, they're going to conduct remote-monitoring simply to
monitor the financial condition of these banks. They're given extra
scrutiny of banks at high levels of CRE concentration--a large amount of
CRE loans. And so what does that mean? Those would be banks that have
300% of their capital assigned to these commercial real estate loans. So
a large amount of loans compared to their capital--or you can think of
equity. And second, also ones who have expanded their CRE portfolio by
50% or more in the last 3 years. These types of banks are getting extra
scrutiny just because of the greater risk associated with it.

[Holly Hobbs:] So are regulators concerned about the situation?

[Michael Clements:] So the regulators have identified CRE exposure as a
risk to banks. Again, they've cited things we've talked about--the
declining prices, again, especially for office space, and also the
losses that some banks that have high concentrations of CRE have
experienced. That said, they've also said they think banks are well
positioned to weather the storm, that bank profits remain profitable at
this point.

{MUSIC}

[Holly Hobbs:] So Mike just told us that banks are working with
borrowers to manage commercial real estate debt--sometimes by extending
loans. And that federal financial regulators are monitoring these risks
too. But they think banks will weather the storm. So, Mike, what's the
bigger picture here in terms of the impacts to our financial system?

[Michael Clements:] Yeah, that's a good question. So, the regulators
have also identified commercial real estate as a potential risk to
financial stability for a lot of the same reasons we've talked about.
They've said it appears that the risks at this point are manageable. The
Federal Reserve conducts stress test on the largest banks, essentially
finding out how would the bank withstand a severe recession, significant
price declines at commercial real estate. And at this point, the banks
are doing well. Those are the large banks. For the smaller banks, they
found that the delinquency rate on commercial real estate at this point
is not significant.

[Holly Hobbs:] Is there anything more we think bank regulators should be
doing to monitor the high volume of commercial real estate loans?

[Michael Clements:] Our report highlights the importance of the
regulators simply to remain vigilant, to continue the monitoring. And
that's consistent domestically with what the Financial Stability
Oversight Council has recommended, and also internationally, the
International Monetary Fund has recommended. So there's a lot of
variability in performance. For example, New York Community Bancorp in
early 2024 required a $1 billion financial infusion because of
significant losses on its commercial real estate portfolio. So again,
speaks to the importance of monitoring banks and realizing that bank
performance is going to vary based upon the type of commercial real
estate that's holding.

[Holly Hobbs:] And last question, what's the bottom line of this report?

[Michael Clements:] Commercial real estate is an important part of the
U.S. economy. It really affects all of our lives. We either live in
commercial real estate, we work in it, or we shop at it. And again, the
performance is going to be very variable cost these types of portfolios.
And therefore it's simply imperative that the regulators continue to
monitor this, to understand how t performance is affecting individual
banks and ensure that cracks don't evolve that could affect the entire
financial system.

[Holly Hobbs:] That was Mike Clements talking about our new report about
commercial real estate loans. Thanks for your time, Mike.

[Michael Clements:] Thank you.

[Holly Hobbs:] And thank you for listening to the Watchdog Report. To
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