‘A reckoning is coming’ as $1 trillion in commercial real estate loans come due

A staggering $1 trillion in commercial real estate (CRE) loans are set to mature over the next two years, putting hundreds of banks at risk, a new report warns.

According to The Conference Board (CB), many banks are dangerously overexposed to CRE loans. This overexposure, coupled with falling property values and rising interest rates, could trigger a wave of bank failures.

Small and midsize banks are in the hottest water.

CB analysts say this segment has lent out far more for commercial properties than its safety nets can comfortably cover, with some having loan exposures more than twice their capital cushions.

CRE prices have already fallen 21% since mid-2022, according to Green Street, a CRE analytics firm. The firm says they could drop by as much as 35% in the coming years.

The roots of this problem trace back to the pandemic, which dramatically changed how we use office spaces and other commercial properties. Simultaneously, property management costs—including insurance, wages, and energy bills—have risen sharply.

This has left many banks overextended on loans, with few buyers willing to take these properties off their hands at current market prices.

Small and midsize banks 'extend and pretend'

According to the report, banks with assets between $100 million and $1 billion have CRE loan values exceeding their risk-based capital by 158%. For banks with assets between $1 billion and $10 billion, this figure jumps to a staggering 228%.

Larger banks, under stricter oversight, are already reporting increases in problem loans.

FDIC data shows that for the biggest banks, seriously delinquent CRE loans have tripled from 1% to 3% since mid-2022. Surprisingly, smaller banks are reporting little change in delinquencies, raising questions about whether they're fully acknowledging the extent of their problems.

Many smaller banks appear to be employing an "extend and pretend" strategy, hoping property values will recover. They're extending loan deadlines rather than acknowledging potential defaults. However, this approach may only delay the inevitable.

‘A reckoning is coming’

The Conference Board report says it’s not a matter of if, but when "a reckoning is coming." A few things could set this off: a further drop in commercial property values, stubbornly high interest rates, or a wave of loan defaults could all be sparks.

The report says that if banks lose just 10% on CRE loans, over 100 smaller banks could be in trouble. If losses hit 20%, it could affect 900 banks, including some bigger ones.

If multiple banks try to raise money at the same time to cover losses, they could face a series of bank runs similar to March 2023, when Silicon Valley Bank collapsed, triggering a wave of withdrawals at other banks.

The end result could be what researchers call "banking deserts"—regions where people and businesses can't access financial services because their local banks have collapsed.

This could seriously hurt local economies, not to mention the contagion of the collapse itself.