Volatility and concerns over potential distress at New York Community Bank and other regional bank lenders could be a trigger for more private credit lenders to intervene on loans facing near-term maturities in a higher-rate environment.

The conversation around bank loan portfolio rose after the bank based in Hicksville, New York, announced last week it would increase its allowance for credit losses to $992 million at the end of the fourth quarter, up from $619 million during the third quarter. NYCB simultaneously posted what some analysts referred to as a surprise loss during the bank’s earnings report.

NYCB’s story is a nuanced one, market participants told affiliate title Real Estate Capital USA, noting that while the regional lender has significant exposure to the office and multifamily sectors, it is also seeing some growing pains because of its acquisition last year of a portion of the $33 billion commercial real estate loan portfolio of New York-based Signature Bank.

NYCB chief executive Thomas Cangemi said the bank has more than doubled in size over the past two years and is both working to adjust to its new scale and align with other banks with more than $100 billion in assets.

Grey area

NYCB’s future is not set in stone and the regional bank’s estimated $76 billion commercial real estate loan portfolio appears stable for now, market participants said.

New York-based manager Cohen & Steers in a report published this week said NYCB’s stress does not signal a systemic problem in the commercial real estate debt industry or broader stress among regional banks.

Cohen & Steers noted the bulk of NYCB’s charge-offs – loans and leases removed from the portfolio and placed against loss reserves – stemmed from two loans, including a New York City residential co-op and an office loan.

“NYCB was under-reserved on office loans at roughly 2 percent compared to more than 8 percent for larger bank peers,” Cohen & Steers’ authors noted. “NYCB played catch-up and increased its reserves for office losses to 8 percent.”

There have been similar situations over the past year in which banks have navigated ways to reduce commercial real estate exposure.

As an example, Capital One, a bank based in McLean, Virginia, sold a roughly $1 billion office loan portfolio to New York-based manager Fortress Investment Group last August to shift its debt exposure away from the sector.

Although it was subsequently acquired and absorbed by Los Angeles-based Banc of California, Beverly Hills-based Pacific Western Bank, as another example, sold off its commercial real estate loan portfolio in three separate deals with firms such as Kennedy Wilson Holdings, Cain International, Security Benefit Life Insurance and Ares Management. PacWest’s template avoided the fate of an FDIC takeover and portfolio auction used to part out what was once Signature’s commercial real estate debt portfolio.

Cohen & Steers noted more banks are anticipated to report commercial real estate loan losses in the coming quarters because of the increased transparency on how much property valuations have declined. This means NYCB is not likely to be the last institution in the headlines for commercial real estate debt issues.

“Further, distress is increasing as delinquency rates climb and a greater volume of loans mature,” Cohen & Steers said in its report. “Banks have been proactively building reserves for future loan losses.”

Joining forces with banks

In an interview this week with CBS’s 60 Minutes, a weekly news broadcast, US Federal Reserve Chair Jerome Powell said he believes the current commercial real estate situation at small and regional banks demonstrates weakness – but is also manageable. In the interview, Powell underscored that he does not believe the situation today in the market will lead to a repeat of the 2007-08 global financial crisis.

What is more likely to happen, at least in the interim, is a situation in which more banks seek to act on loans with near-term maturities or distressed capital stacks.

“The number of banks with substantial concentrations of real estate on their balance sheets relative to their capital is shockingly large. That will have to start to be realised and resolved,” said Pat Jackson, chief executive of Sabal Investment Holdings, a manager based in Irvine, California.

This realisation has meant that Sabal Investment Holdings is seeing a rise in transactions through which the manager can co-originate loans with banks.

“We are doing deals on a one-off basis and are also starting to see portfolios come to us,” Jackson said.

The firm has completed three deals of this kind in the past few weeks, including the origination of a $64.5 million loan to finance the conversion of the LaGuardia Plaza Hotel, and expects to do more as banks take harder looks at their balance sheets, said Jackson.

Sabal completed the financing on the 353-room property at 10404 Ditmars Boulevard in Queens, New York, with Bsafal and Argo Real Estate. Synergy Hospitality Group, based in Wayne, Pennsylvania, was the sponsor.

“In that transaction, we were part of the solution for a bank to do some balance sheet work,” Jackson added. “The hotel is part of a maturing loan refi, and we are coming in with new capital, a new structure and a refi that matches where valuations are today, not where they were.”

Jackson believes banks this year will need to start resolving troubled loans and reduce their commercial real estate exposures.

Tax implications

As banks look to resolve potential problems with their balance sheets, there is a greater conversation about what will happen with all the debt that is coming due over the near term as well as the potential tax implications of workouts or restructurings for commercial real estate owners, said Rob Gilman, a partner at New York-based advisory Anchin.

“Modifications are different than foreclosures,” Gilman said. “You can modify the payment terms, or you could do a modification in which the size of the loan is adjusted. Banks are willing to do that but any situation in which there is forgiveness around the amount of debt counts as a cancellation of debt and this could mean a 35-40 percent tax hit, depending on how much has been forgiven.”

He continued: “I think every bank is willing to have this conversation, but no one wants to poke the bear, especially if their debt is not due for eight or even 12 months. Many investors are holding off on talking to banks because of an expectation that rates will decrease. I don’t think rates will decrease enough to make much of a difference, but these conversations need to be had.”

In addition to the tax implications of debt modifications and foreclosures, commercial real estate owners need to be aware of cost segregation studies and taking advantage of bonus depreciation. Tax planning, Gilman added, is a 12-month activity.

What’s next

One question the market continues to grapple with is the size and timing of rate cuts. While some optimistic market participants are anticipating the potential for a 150-basis point decline in interest rates over the next 18 months, the consensus is that any rate drops will be less aggressive.

“We are not getting back to time of 4 percent mortgage rates,” Gilman said. “The problem is not necessarily the rates but the valuations and what banks are willing to accept.”

The market has seen banks like New York Community Bank increasing their reserves in anticipation of a rise in distress, with Gilman noting this could have an impact on the number of lenders active on the commercial side. In addition to private credit providers funding gap capital, there could be more opportunistic buyers.

“I’m not sure how many lenders will be out there for the commercial side. This is where we will start to see vulture funds with loan-to-own strategies. That may be where we are going,” Gilman said.