If at first you don’t succeed, try again. An admirable adage, but one that has some potential consequences when dealing with CRE loans that borrowers can’t manage to refinance. The practice, as the Financial Times noted, has led to a rise in double defaults. By the end of September has led to re-defaults being up 90% compared to 2023.
As properties ran into maturity or slid off the payment road and skidded toward the default curb, banks have managed problems with the so-called extend-and-pretend (or delay-and-pray for some of the more skeptical) strategy. Modify the loan, extend it, and hope for the Federal Reserve to cut rates fast enough so borrowers could refinance and the whole problem could be swept away without disturbing a bank’s balance sheet.
Bank loan workouts have surged this year, according to CRED iQ, “placing 2024 squarely on a path to a record-setting year of loan modifications.” In 2023, the total modifications were $16.8 billion. The average monthly volume of modifications was $1.8 billion, with April seeing the highest volume of $3 billion. As of the end of May 2024, about $22 billion in loans received modifications by lenders. Just in 2024, there were $9 billion in modifications.
This carries dangers. Default once, get an extension or other workout, and the bank and borrower could face a second default. According to the FT analysis of data from industry tracker BankRegData, the country since 2014 is seeing the highest level of CRE borrowers getting relief and then becoming delinquent again.
There is a history of extend-and-pretend critiques. Some people were saying in 2009, after the Global Financial Crisis, that extend-and-pretend wasn’t a solution.
As a recent study out of the New York Fed stated, “banks ‘extended-and-pretended’ their impaired CRE mortgages in the post-pandemic period to avoid writing off their capital, leading to credit misallocation and a buildup of financial fragility.”
“Extend-and-pretend crowds out new credit provision, leading to a 4.8–5.3 percent drop in CRE mortgage origination since 2022:Q1 and fuels the amount of CRE mortgages maturing in the near term,” the researchers wrote. “As of 2023:Q4, this ‘maturity wall’ represents 27 percent of bank capital.”
The FT reported that while the percentage of nearly $2 trillion in CRE loans banks have lent and fallen into delinquency. It’s still $26 billion, a 25% increase during the first three quarters of 2024. A Moody’s examination found banks offered little in payment breaks. Instead, borrowers could delay missed payments.
“They are kicking the can down the road,” Ivan Cilik, a principal with accounting firm Baker Tilly’s financial services group, told the FT. “I think lenders are trying to work out the problems with these loans, but if rates don’t come down borrowers are not going to be able to make payments.”
“We are in the early part of the curve,” Cilik said. “If we continue to see rising delinquencies, we will know that these modifications are just not working out.”
And Fed Chair Jerome Powell made clear in the press conference after this week’s meeting of the Federal Open Market Committee, that there is no rush to drive down interest rates. The cavalry is not mounting their steeds for a furious ride to the rescue.