What Mortgage Bonds Say About the Office Meltdown

Commercial mortgage-backed securities account for 14% of U.S. commercial real-estate lending and are a good proxy.
Commercial mortgage-backed securities account for 14% of U.S. commercial real-estate lending and are a good proxy.


Commercial mortgage-backed securities make a troubling proxy for the loans on banks’ balance sheets.

Bank ructions caused by bad U.S. office loans are only getting started, if one corner of the lending market is anything to go by.

Banks issue around half of all commercial real-estate loans in the U.S. They don’t always give much detail about the health of the loans or the buildings they have lent against until it is too late. The first investors hear of problems may be when lenders set aside hundreds of millions of dollars as provisions for likely future losses, as happened recently at New York Community Bancorp and Japan’s Aozora Bank. The lenders’ shares have tanked 53% and 34%, respectively, since they revealed souring U.S. office loans in recent weeks.

There is an indirect way to get a picture of the pressures building on some banks’ loan books. Commercial mortgage-backed securities account for 14% of U.S. commercial real-estate lending and are a good proxy. Helpfully, the CMBS market spews monthly data about default rates and the latest building valuations.

What happened to the billions of dollars of office CMBS debt that matured last year, which property watchers have been so worried about? According to CRED iQ, a real-estate data provider, only 26% of the $35.8 billion of office CMBS loans that matured in 2023 was actually paid off in full, as borrowers struggled to get refinancing or to sell their properties.

Some maturing mortgages were extended, others were transferred to a special servicer—a third party who tries to find the best outcome for the debt, which may include an extension, renegotiated terms or foreclosing on the property. More than 1,000 CMBS office loans with a total value of $14.8 billion are now with a special servicer.

The pool of troubled loans is growing, with 10.5% of CMBS office debt in distress by the end of January. Distressed loans are those that are more than 30 days late paying or have been transferred to a special servicer. This is more than triple the rate seen a year ago and is likely to rise as an additional $46.6 billion of CMBS office loans come due through 2025, CRED iQ data shows.

The office valuation data from the CMBS market looks grim. When loans are transferred to a special servicer, the buildings get an up-to-date appraisal to determine their fair market price. Of a list of 220 troubled loans that have recent reappraisal data, the average valuation decline for offices is 40%, according to CRED iQ. Buildings that were revalued in 2023 have plunged almost 50%.

The loans on banks’ books might not be quite as bad as this. Banks have probably been more conservative with their loan-to-value ratios and they have wiggle room to negotiate with borrowers behind closed doors. Also, as CMBS loans are non-recourse, it is easier for landlords to hand back the keys if the debt is worth more than the building itself. Bank borrowers have more on the line if they have personally guaranteed the loan.

But loan maturities will still trigger unpleasant surprises for bank shareholders. And the trickle of office buildings selling at steep discounts makes it harder for banks to “pretend and extend." Data from office deals will increasingly need to be factored into loan valuations.

Identifying where the next problem might blow up is tricky. There are billions of dollars of office debt sitting on the books of American and international banks, but detailed disclosure about who owns loans on a property-by-property basis isn’t great, according to Rich Hill, senior vice president at real-estate investment firm Cohen & Steers.

“We know it’s a problem, but it’s hard to precisely state to what degree across lenders," he said.

Stand in the middle of the business district of any big U.S. city and the nearby buildings are emptier and a lot less valuable than they were four years ago. Listed office real-estate investment trusts have already faced the music: The S&P 500 Office REITs Sub-Industry Index has roughly halved in value since before the pandemic. The reality check for banks is just beginning.

Write to Carol Ryan at carol.ryan@wsj.com

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