Not all commercial real-estate loans are created equal.
In Wednesday’s Journal we reported that U.S. banks have been “slow” to take losses on battered commercial real-estate loans, according to a Federal Reserve presentation to banking regulators last month.
So which are the most toxic loans?
The answer will sound familiar to anyone who’s followed the subprime mortgage meltdown. The Fed presentation points to Interest-only loans, held by banks or repackaged into securities, as the most poisoned piece of the commercial real-estate pie.
Interest-only loans allow borrowers to pay only the interest on the loan for a set period of time but no principal. A lot of these loans were made at the market peak, get no benefit from amortization and have seen a decline of more than 45% in the values of the properties backing the loans, the Fed presentation notes.
As a result, borrowers with these loans likely will a hard time refinancing when they come due. From 2010 through 2013, about $175 billion of five-year interest-only loans bundled into CMBS will mature, but that figure would be much bigger when it comes to interest-only commercial loans held by banks. “CMBS dollar amount is low compared to bank ‘IO’ problem,” says the Fed report, referring to interest only.
Another interesting point made by the Fed presentation is that while commercial real estate is continuing to decline, the reason for the drop is shifting. Up until now, values have dropped about 30% from the peak primarily because of the evaporation of capital and a massive recalculation of risk within the industry, it says. Buyers are demanding much lower prices and higher yields to compensate for the risk they’re taking on.