February 11, 2025 • 19 mins
On the latest episode of the ABA Banking Journal Podcast — presented by R&T Deposit Solutions — ABA’s Jeff Huther and Sharon Whitaker rebut a false narrative about how banks are managing commercial real estate credit risk. Expanding on a rebuttal to a New York Fed paper, they explore why measures of distress and undercapitalization used by the New York Fed and some in the media are inconsistent with common definitions and ignore bank-borrower relationships, accounting principles and valuation techniques.
“We’re now almost three years past the last shock to the sector, and people have had a lot of time to kind of think through how to deal with this and what the implications are for credit risk,” says Huther. “We’re in a situation where ” extending and pretending” is just not the right way to describe the condition and market.”
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Sharon Whitaker (00:03):
A maturity wall in having a loan mature is a normal
credit enhancement, credit riskmanagement tool that bankers do.
They touch a file multiple times a year.
They and it required atleast annually to look at it.
It gives a good way to look at repricing.
(00:25):
Look at your debt service coverage.
Look at your net operating incomeor get the borrower's net operating
income to look forward looking howit's going to perform in the future.
Evan Sparks (00:42):
From the American Bankers Association, this is
the ABA Banking Journal podcast.
Welcome back.
I'm Evan Sparks.
Today's episode is presented byR&T Deposit Solutions, and I'm here
with two of my colleagues who areexperts on commercial real estate
finance and and the economics aroundcommercial real estate finance.
We have Sharon Whitaker, who is a VPfor CRE finance policy here at ABA.
(01:04):
Hi, Sharon.
Sharon Whitaker (01:04):
Hello.
Evan Sparks (01:06):
And we also have Jeff Huther, who is a VP for Banking
and Economic Policy Research inour Office of the Chief Economist.
Jeff good to see you.
Jeff Huther (01:13):
Good to see you as well.
Thank you.
Evan Sparks (01:15):
So I, I wanted to bring y'all here together today.
You and, and one, one other ABAcolleague recently wrote an ABA data
bank Essay on critiquing a paper fromthe New York Fed called, "Extend and
Pretend in the U. S. CRE Market."And this is up on our website at ABA.
com slash banking journal.
(01:37):
The, the, the the response to this paperand so I'd love it if maybe Jeff, if you
could kind of give us a quick summaryof what the New York Fed put out or the
New York Fed researchers have publishedand then why and then, and then we'll
get into some of the details about whywe disagree, why you disagree with this
assessment and what things actuallylook like in the CRE sector today.
Jeff Huther (02:00):
Well, briefly, the authors argue that banks are engaged in taking
troubled loans and, and the processof extending their maturities lease.
Okay.
and pretending that they're good loanswhen in fact they're likely to default.
And these loans, and they're focusedon the commercial real estate sector.
(02:23):
And then they identifyconsequences of this practice.
By saying it increases financialfragility and it crowds out provision
of credit by, by affected banks.
And that it's leading to a maturity wall,which could lead to a disastrous outcome.
Evan Sparks (02:43):
Yeah.
So Sharon, I'd love it if you couldkind of talk through a little bit, what
is this whole concept of "extend andpretend" and how does this, you know how
does this work in the, in the, in thebanking se sec, in the banking sector for
any, for folks who are not f as familiarwith commercial real estate finance?
Sharon Whitaker (03:00):
Sure enough.
And, and I'm gonna just let you know, mypet peeve to start with the phrase extend
and pretend is to me offensive as a formerbanker and, and those of our members
that are, that are in the industry.
I mean, it is an accountingstandard that you really have
to assess each of your credits.
And take a look at whether or not it'simpaired or not impaired and where the
(03:25):
valuation and manage each credit to implythat you're extending and pretending that
the loan is going to perform actually isit goes against all accounting principles
that banks are required to follow.
So, with that said, I think Extendand Defend is a great title for those
(03:46):
creative folks that came up with itreally to describe what's happening.
A maturity wall in having a loan matureis a normal credit enhancement, credit
risk management tool that bankers do.
They touch a file multiple times a year.
They and it required atleast annually to look at it.
(04:09):
It gives a good way to look at repricing.
Look at your debt service coverage.
Look at your net operating incomeor get the borrower's net operating
income to look forward looking howit's going to perform in the future.
So those maturity walls which are areally large discussion here, really
(04:32):
are a normal management tool forbanks and it's not unusual to do so.
Jeff, I'm gonna pause to see ifyou have anything to add to that.
I don't wanna go too deep inthe weeds, but I don't wanna
give a gi good, broad aspect.
Jeff Huther (04:49):
No, I think that's a nice start.
Evan Sparks (04:50):
We've seen this in some of the other areas, you know, with the
CFPB using the term "junk fees" where,you're setting the table for a discussion
with the terms you choose to use.
And so so obviously we're usingthis term to in this, for the
purposes of this conversation,because we're discussing this paper.
But, you know, Jeff, I'd love it if youcould kind of walk us through some of
(05:11):
the data that you saw, you know, the, theanalysis in the paper, you know, what was.
You, we talked, you talked in the articleabout some of the definitional weaknesses
about these, you know, the weaknesses andthe, how do we characterize it, in which
Sharon already talked a little bit about,with this concept of extend to pretend.
What are some of the other weaknessesthat you see in the in this paper, and
why did ABA office of the Chief Economistthink it was important to respond to it?
Jeff Huther (05:36):
Okay.
Well, maybe starting at the backand, you know, we felt as though it
was important to respond because it,this, the paper had gained some, some
attraction in the press and you know,not, and, you know, largely based on the,
the title being kind of a sexy topic.
Well, maybe there's a problem here that isgoing to bring down the financial system
(05:59):
again because banks are hiding weaknesses.
Yeah.
And that, that whole story is built onthe, the author's use of data that we
can't see that this is data that bankshave to provide to regulators and is and
as a result, we can't tell exactly whatthey did, but what we see from how they
(06:23):
describe the, the approach Is one thatsuggests there's some pretty substantial
weaknesses in both the idea that thereare vulnerabilities here and that banks
are doing something nefarious in some way.
The authors have loan leveldata on 22 large banks.
They identify the banks, but, you know, wedon't have any information on the loans.
(06:45):
And say that, well, 7 percent of theseloans are commercial real estate,
which is consistent with kind of thenational data, but we find, you know,
and separately we found, you know,just a small portion of So, yeah.
Commercial real estate loans are tothe, the, the sectors that we would
(07:06):
think of as vulnerable at this point,the office sector in particular.
So you take 7 percent and then you'dtake a much smaller portion of that.
And you'd say, well, okay, thatthere's some, some number out
there for these office towers inthe major cities that are exposed.
And the authors don't even go that intothat kind of depth they're, they're kind
(07:28):
of focusing on this broader 7 percentnumber and saying, well, that's, that's a
sign of vulnerability across the industry.
And then the, the authors use pricingfrom real estate investment trusts.
As a basis for the shocks thatthey're going to say, Okay, there's
how, how badly hit as the commercialreal estate sector been affected.
(07:53):
And, you know, the one of theobvious problem with that is
that real estate pricing while.
The real estate that investment trustpricing is readily available and
presumably reflects the underlyingexposures of the these trusts to
the real estate they've invested in.
They're levered.
(08:14):
And that magnifies the effects.
So if you saw investment trust thathad fallen 20 percent in value say,
but it's, it's levered to to that itborrowed half of that, it would imply
that investors have seen exposures ofthe underlying investment fall only by 10
(08:35):
percent rather than the 20 percent thatthe value of that trust falls by as a
result, it overstates as a starting point.
The, the potential losses forthose for those investments.
And then there's no clear relationshipbetween those investments and what
the banks have invested in, you knowand banks in having even in the office
(08:57):
sector, I have been strong investorsin things that are unrelated to central
business district office buildingsthat have been seeing prices fall.
Just as a starting point, there's,there's some room there for, for saying
guys, you may be overstating the problem.
Secondly, the authors developed a coupleof metrics that are questionable as, as
(09:23):
ways to define financial vulnerability.
Their first measure is somethingcalled distress and They define that
as any deterioration and all at allin that operating income and it, you
know, net operating income from theday one when the loan is originated to
(09:43):
where we are now or when the authorsfinish their data at the end of 2023.
You know, that can be an increase intaxes, obviously rates have gone up
interest rates have gone up, you know,your, your cleaning fees for a building
could go up it's not clear that that wouldnecessarily signal that there's distress.
(10:06):
So it, it it's, it's probably anoverblown kind of descriptor of,
of what the authors are measuring.
You know, I, obviously it'd be nice froma lender's point of view if net operating
income continued to increase as theloan aged, but it's not necessarily a
sign of distress as the authors call it.
(10:30):
And then their second measure offinancial vulnerability here is what
they're calling undercapitalization,where they take the bank's capital, and
then they bring in unrealized lossesfrom securities portfolio that have
obviously been well undercapitalized.
Publicized in the in, in, in the pressand elsewhere and because of the, the,
(10:54):
the sharp rise in interest rates thathappened in 2022 this, and then, you
know, so bank, this 20 list of 22 banksthat the, the authors look at, they say,
okay, the, the, the top 11 banks in termsof capital requirements, we're going to
call well capitalized and the bottom 12 or11 we're going to call undercapitalized.
(11:22):
So again, we've got some overblownlanguage here of what's well
capitalized versus undercapitalized.
They're just drawing a line inthe middle and saying, well, you
guys are undercapitalized and thenassociating the commercial real
estate findings to this, this metric.
And that's where they get into this.
Oh, well, bank, these, these vulnerablebanks, these undercapitalized
(11:46):
or distressed banks are theones that are extending loans.
So that's, that's the basicstructure of the data.
I'm sorry.
I'm sure that's a lot more detailed thanyour listeners want to hear, but that's
Evan Sparks (11:59):
Oh, it's, it's great.
Let me take a quick moment here tothank our sponsor for this episode.
R&T Deposit Solutions provides banks,broker dealers, trust companies, and
other financial institutions withflexible cash sweep and deposit funding
solutions designed to protect theircustomers funds and grow their businesses.
You can learn more about R&TDeposit Solutions the letters RNT.
com.
And thanks again to R&T DepositSolutions for sponsoring this episode.
(12:23):
So coming back to this conversation youknow, Sharon, I just love it if you could
kind of give us a sense of, you knowlooking at this data, how does it map
onto, you know, the way that commercialreal estate that, that CRE lending banks
are actually managing their exposureto real estate losses and what the
actual intersection is between CRE andC&I lending right now in the industry.
Sharon Whitaker (12:47):
So if you don't mind, I'd like to back up to a couple
of comments that Jeff made, theassumption that any decrease in net
operating income is going to make aloan distressed and likely to default.
As Jeff said, it doesn't even consider thefact that it may still be performing above
a one to one debt debt service coverage.
(13:08):
So they make this broad assumptionthat any type of decrease,
you know, it might've beenunderwritten at one, three, five.
It might be at one, two, five rightnow, which is still performing loan
that because of that decrease thatthere's going to be a future loss.
The other problem that Jeffkind of mentioned, and I want to
enhance a little bit is that thesereads that you're looking at you
(13:32):
know what they're trading at.
Is not necessarily an assumption ofwhat the underlying value is to the to
what's collateralizing it So I see acomplete mismatch there But when you
look at our community banks and allof the member banks that we have all
different sizes Not many of them havethese really large exposures to the
(13:55):
central business district You know manyof them, you know are within their market.
They may be different strip malls.
They may be You know,whoever is located there.
They really have that boots onthe ground management tool that
they know where the leases are.
They're looking forward 24 months fromwhen a loan might mature as far as an
(14:18):
even where the interest rate may go.
They're doing Stressing of all ofthe loans on an individual basis,
let alone their entire portfolio.
So they're doing a bottom up in a topdown stress scenario on all these loans.
So they actually have their thumb on theperformance of it on a go forward basis.
So I think when you look at Any decreaseis going to make this assumption.
(14:42):
And then, as Jeff mentioned, togo back to another point, that
within their investment portfolio,they're hiding massive losses there.
Well, within their investment portfolio,these are not mark to market investments.
These are held to maturity.
So there's a lot of assumptions in herethat really kind of says, Oh my God, the
(15:02):
banking Industry is in so much distressthat we have so much to worry about.
And there's there.
Undercapitalized and therefore,you know, they're really
pushing these loans forward.
They may be on what I'll call a watchlist, which the anyone listened to it
knows what it is, and it may not be aclassified asset and a bank actually
(15:26):
has to measure that risk rating.
As I mentioned before, look at impairment.
Write it down if necessary.
Mark to mark it if there aresome really strong underlying.
Many of our banks are going inthere and I'm giving you more of an
explanation than you ever asked for.
But they're also looking atthe covenants, securing these.
(15:47):
So as they're touching these loans18 to 24 months in advance of its
maturity, they may be adding Covenants.
They may be getting cash from aguarantor or, you know, whatever
type of structure this loan has tomake sure where are these leases?
Where are they expiring?
Do they have, you know,sub leases coming in?
(16:08):
What is the overallperformance of the loan itself?
So there's so much more tactilemanagement and really enhanced
credit management there.
If you don't mind, I'mgoing to add one more thing.
Evan Sparks (16:23):
Please do.
Sharon Whitaker (16:24):
The prudential regulators are telling the banks, they have not
pulled back any of their memos, workwith your borrowers, make sure they're
performing, measure it correctly, but youshould be working with your borrowers.
And I, I just got that itchy feelinglike they were discouraging banks
to working with, with borrowersto really, if there's any type of
(16:47):
decrease to get them through that, butmake sure they're still performing.
Evan Sparks (16:51):
Yeah, that's you know, that, that makes a lot of sense.
The you know, you're, if regulatorsaren't, aren't nervous about this,
if there's, you know, if you,it, it seems like there's a kind
of a, a much ado about nothing.
And honestly, a bit of a,an effort to kind of create
something, something that's.
You know, fabricates somekind of a little bit of drama.
(17:13):
That's actually not borneout by the data here.
Sharon Whitaker (17:16):
Yeah.
And I think there's a fear,you know, that, that the
valuations could, could plummet.
Central business district hashad their issues, but, you know,
I think it's almost a bit of a ringingthe bell, scaring a little bit ahead
of time before it perhaps could happen.
Evan Sparks (17:34):
And it certainly, if we, as we've talked about previously on
this show and, and in your, your, yourABA databank pieces, you know, the.
Community banks and mid sized banks inparticular have very minimal exposure
to some of these CBD sectors and you'remeanwhile you have a lot of exposure to
CRE sectors that are performing extremelywell like industrial and data center and
(17:55):
hospitality and all kinds of other sectorsthat you know doing great right now.
So this was really helpful.
Any final thoughts before we beforewe close off the close the discussion?
Jeff Huther (18:05):
The commercial real estate weaknesses are not hidden.
So it, and they've been around sincethe both the pandemic and then,
you know, with the second hit oninterest rates increases in 2022.
So, you know, we're now almost twoand a half years past that three
years past the, the, the last shockto the sector, and people have had a
(18:28):
lot of time to kind of think through.
How to deal with this and what theimplications are for for for credit risk.
So you know, I'd say we're we'rewe're in a situation where extending
and print pretending and it'sjust not the right right way to
describe the condition and mark.
All right.
Evan Sparks (18:50):
Well, thanks for being on the show with us today.
Thanks to R&T Deposit Solutionsfor sponsoring this episode.
You can find the the essay byJeff and Sharon and our, and our
colleague Dan Brown on a at aba.
com slash banking journal.
Thanks so much for listening.
And we'll be back withyou again, very soon.
A maturity wall in having a loan mature is a normal
credit enhancement, credit riskmanagement tool that bankers do.
They touch a file multiple times a year.
They and it required atleast annually to look at it.
It gives a good way to look at repricing.
(00:25):
Look at your debt service coverage.
Look at your net operating incomeor get the borrower's net operating
income to look forward looking howit's going to perform in the future.
Evan Sparks (00:42):
From the American Bankers Association, this is
the ABA Banking Journal podcast.
Welcome back.
I'm Evan Sparks.
Today's episode is presented byR&T Deposit Solutions, and I'm here
with two of my colleagues who areexperts on commercial real estate
finance and and the economics aroundcommercial real estate finance.
We have Sharon Whitaker, who is a VPfor CRE finance policy here at ABA.
(01:04):
Hi, Sharon.
Sharon Whitaker (01:04):
Hello.
Evan Sparks (01:06):
And we also have Jeff Huther, who is a VP for Banking
and Economic Policy Research inour Office of the Chief Economist.
Jeff good to see you.
Jeff Huther (01:13):
Good to see you as well.
Thank you.
Evan Sparks (01:15):
So I, I wanted to bring y'all here together today.
You and, and one, one other ABAcolleague recently wrote an ABA data
bank Essay on critiquing a paper fromthe New York Fed called, "Extend and
Pretend in the U. S. CRE Market."And this is up on our website at ABA.
com slash banking journal.
(01:37):
The, the, the the response to this paperand so I'd love it if maybe Jeff, if you
could kind of give us a quick summaryof what the New York Fed put out or the
New York Fed researchers have publishedand then why and then, and then we'll
get into some of the details about whywe disagree, why you disagree with this
assessment and what things actuallylook like in the CRE sector today.
Jeff Huther (02:00):
Well, briefly, the authors argue that banks are engaged in taking
troubled loans and, and the processof extending their maturities lease.
Okay.
and pretending that they're good loanswhen in fact they're likely to default.
And these loans, and they're focusedon the commercial real estate sector.
(02:23):
And then they identifyconsequences of this practice.
By saying it increases financialfragility and it crowds out provision
of credit by, by affected banks.
And that it's leading to a maturity wall,which could lead to a disastrous outcome.
Evan Sparks (02:43):
Yeah.
So Sharon, I'd love it if you couldkind of talk through a little bit, what
is this whole concept of "extend andpretend" and how does this, you know how
does this work in the, in the, in thebanking se sec, in the banking sector for
any, for folks who are not f as familiarwith commercial real estate finance?
Sharon Whitaker (03:00):
Sure enough.
And, and I'm gonna just let you know, mypet peeve to start with the phrase extend
and pretend is to me offensive as a formerbanker and, and those of our members
that are, that are in the industry.
I mean, it is an accountingstandard that you really have
to assess each of your credits.
And take a look at whether or not it'simpaired or not impaired and where the
(03:25):
valuation and manage each credit to implythat you're extending and pretending that
the loan is going to perform actually isit goes against all accounting principles
that banks are required to follow.
So, with that said, I think Extendand Defend is a great title for those
(03:46):
creative folks that came up with itreally to describe what's happening.
A maturity wall in having a loan matureis a normal credit enhancement, credit
risk management tool that bankers do.
They touch a file multiple times a year.
They and it required atleast annually to look at it.
(04:09):
It gives a good way to look at repricing.
Look at your debt service coverage.
Look at your net operating incomeor get the borrower's net operating
income to look forward looking howit's going to perform in the future.
So those maturity walls which are areally large discussion here, really
(04:32):
are a normal management tool forbanks and it's not unusual to do so.
Jeff, I'm gonna pause to see ifyou have anything to add to that.
I don't wanna go too deep inthe weeds, but I don't wanna
give a gi good, broad aspect.
Jeff Huther (04:49):
No, I think that's a nice start.
Evan Sparks (04:50):
We've seen this in some of the other areas, you know, with the
CFPB using the term "junk fees" where,you're setting the table for a discussion
with the terms you choose to use.
And so so obviously we're usingthis term to in this, for the
purposes of this conversation,because we're discussing this paper.
But, you know, Jeff, I'd love it if youcould kind of walk us through some of
(05:11):
the data that you saw, you know, the, theanalysis in the paper, you know, what was.
You, we talked, you talked in the articleabout some of the definitional weaknesses
about these, you know, the weaknesses andthe, how do we characterize it, in which
Sharon already talked a little bit about,with this concept of extend to pretend.
What are some of the other weaknessesthat you see in the in this paper, and
why did ABA office of the Chief Economistthink it was important to respond to it?
Jeff Huther (05:36):
Okay.
Well, maybe starting at the backand, you know, we felt as though it
was important to respond because it,this, the paper had gained some, some
attraction in the press and you know,not, and, you know, largely based on the,
the title being kind of a sexy topic.
Well, maybe there's a problem here that isgoing to bring down the financial system
(05:59):
again because banks are hiding weaknesses.
Yeah.
And that, that whole story is built onthe, the author's use of data that we
can't see that this is data that bankshave to provide to regulators and is and
as a result, we can't tell exactly whatthey did, but what we see from how they
(06:23):
describe the, the approach Is one thatsuggests there's some pretty substantial
weaknesses in both the idea that thereare vulnerabilities here and that banks
are doing something nefarious in some way.
The authors have loan leveldata on 22 large banks.
They identify the banks, but, you know, wedon't have any information on the loans.
(06:45):
And say that, well, 7 percent of theseloans are commercial real estate,
which is consistent with kind of thenational data, but we find, you know,
and separately we found, you know,just a small portion of So, yeah.
Commercial real estate loans are tothe, the, the sectors that we would
(07:06):
think of as vulnerable at this point,the office sector in particular.
So you take 7 percent and then you'dtake a much smaller portion of that.
And you'd say, well, okay, thatthere's some, some number out
there for these office towers inthe major cities that are exposed.
And the authors don't even go that intothat kind of depth they're, they're kind
(07:28):
of focusing on this broader 7 percentnumber and saying, well, that's, that's a
sign of vulnerability across the industry.
And then the, the authors use pricingfrom real estate investment trusts.
As a basis for the shocks thatthey're going to say, Okay, there's
how, how badly hit as the commercialreal estate sector been affected.
(07:53):
And, you know, the one of theobvious problem with that is
that real estate pricing while.
The real estate that investment trustpricing is readily available and
presumably reflects the underlyingexposures of the these trusts to
the real estate they've invested in.
They're levered.
(08:14):
And that magnifies the effects.
So if you saw investment trust thathad fallen 20 percent in value say,
but it's, it's levered to to that itborrowed half of that, it would imply
that investors have seen exposures ofthe underlying investment fall only by 10
(08:35):
percent rather than the 20 percent thatthe value of that trust falls by as a
result, it overstates as a starting point.
The, the potential losses forthose for those investments.
And then there's no clear relationshipbetween those investments and what
the banks have invested in, you knowand banks in having even in the office
(08:57):
sector, I have been strong investorsin things that are unrelated to central
business district office buildingsthat have been seeing prices fall.
Just as a starting point, there's,there's some room there for, for saying
guys, you may be overstating the problem.
Secondly, the authors developed a coupleof metrics that are questionable as, as
(09:23):
ways to define financial vulnerability.
Their first measure is somethingcalled distress and They define that
as any deterioration and all at allin that operating income and it, you
know, net operating income from theday one when the loan is originated to
(09:43):
where we are now or when the authorsfinish their data at the end of 2023.
You know, that can be an increase intaxes, obviously rates have gone up
interest rates have gone up, you know,your, your cleaning fees for a building
could go up it's not clear that that wouldnecessarily signal that there's distress.
(10:06):
So it, it it's, it's probably anoverblown kind of descriptor of,
of what the authors are measuring.
You know, I, obviously it'd be nice froma lender's point of view if net operating
income continued to increase as theloan aged, but it's not necessarily a
sign of distress as the authors call it.
(10:30):
And then their second measure offinancial vulnerability here is what
they're calling undercapitalization,where they take the bank's capital, and
then they bring in unrealized lossesfrom securities portfolio that have
obviously been well undercapitalized.
Publicized in the in, in, in the pressand elsewhere and because of the, the,
(10:54):
the sharp rise in interest rates thathappened in 2022 this, and then, you
know, so bank, this 20 list of 22 banksthat the, the authors look at, they say,
okay, the, the, the top 11 banks in termsof capital requirements, we're going to
call well capitalized and the bottom 12 or11 we're going to call undercapitalized.
(11:22):
So again, we've got some overblownlanguage here of what's well
capitalized versus undercapitalized.
They're just drawing a line inthe middle and saying, well, you
guys are undercapitalized and thenassociating the commercial real
estate findings to this, this metric.
And that's where they get into this.
Oh, well, bank, these, these vulnerablebanks, these undercapitalized
(11:46):
or distressed banks are theones that are extending loans.
So that's, that's the basicstructure of the data.
I'm sorry.
I'm sure that's a lot more detailed thanyour listeners want to hear, but that's
Evan Sparks (11:59):
Oh, it's, it's great.
Let me take a quick moment here tothank our sponsor for this episode.
R&T Deposit Solutions provides banks,broker dealers, trust companies, and
other financial institutions withflexible cash sweep and deposit funding
solutions designed to protect theircustomers funds and grow their businesses.
You can learn more about R&TDeposit Solutions the letters RNT.
com.
And thanks again to R&T DepositSolutions for sponsoring this episode.
(12:23):
So coming back to this conversation youknow, Sharon, I just love it if you could
kind of give us a sense of, you knowlooking at this data, how does it map
onto, you know, the way that commercialreal estate that, that CRE lending banks
are actually managing their exposureto real estate losses and what the
actual intersection is between CRE andC&I lending right now in the industry.
Sharon Whitaker (12:47):
So if you don't mind, I'd like to back up to a couple
of comments that Jeff made, theassumption that any decrease in net
operating income is going to make aloan distressed and likely to default.
As Jeff said, it doesn't even consider thefact that it may still be performing above
a one to one debt debt service coverage.
(13:08):
So they make this broad assumptionthat any type of decrease,
you know, it might've beenunderwritten at one, three, five.
It might be at one, two, five rightnow, which is still performing loan
that because of that decrease thatthere's going to be a future loss.
The other problem that Jeffkind of mentioned, and I want to
enhance a little bit is that thesereads that you're looking at you
(13:32):
know what they're trading at.
Is not necessarily an assumption ofwhat the underlying value is to the to
what's collateralizing it So I see acomplete mismatch there But when you
look at our community banks and allof the member banks that we have all
different sizes Not many of them havethese really large exposures to the
(13:55):
central business district You know manyof them, you know are within their market.
They may be different strip malls.
They may be You know,whoever is located there.
They really have that boots onthe ground management tool that
they know where the leases are.
They're looking forward 24 months fromwhen a loan might mature as far as an
(14:18):
even where the interest rate may go.
They're doing Stressing of all ofthe loans on an individual basis,
let alone their entire portfolio.
So they're doing a bottom up in a topdown stress scenario on all these loans.
So they actually have their thumb on theperformance of it on a go forward basis.
So I think when you look at Any decreaseis going to make this assumption.
(14:42):
And then, as Jeff mentioned, togo back to another point, that
within their investment portfolio,they're hiding massive losses there.
Well, within their investment portfolio,these are not mark to market investments.
These are held to maturity.
So there's a lot of assumptions in herethat really kind of says, Oh my God, the
(15:02):
banking Industry is in so much distressthat we have so much to worry about.
And there's there.
Undercapitalized and therefore,you know, they're really
pushing these loans forward.
They may be on what I'll call a watchlist, which the anyone listened to it
knows what it is, and it may not be aclassified asset and a bank actually
(15:26):
has to measure that risk rating.
As I mentioned before, look at impairment.
Write it down if necessary.
Mark to mark it if there aresome really strong underlying.
Many of our banks are going inthere and I'm giving you more of an
explanation than you ever asked for.
But they're also looking atthe covenants, securing these.
(15:47):
So as they're touching these loans18 to 24 months in advance of its
maturity, they may be adding Covenants.
They may be getting cash from aguarantor or, you know, whatever
type of structure this loan has tomake sure where are these leases?
Where are they expiring?
Do they have, you know,sub leases coming in?
(16:08):
What is the overallperformance of the loan itself?
So there's so much more tactilemanagement and really enhanced
credit management there.
If you don't mind, I'mgoing to add one more thing.
Evan Sparks (16:23):
Please do.
Sharon Whitaker (16:24):
The prudential regulators are telling the banks, they have not
pulled back any of their memos, workwith your borrowers, make sure they're
performing, measure it correctly, but youshould be working with your borrowers.
And I, I just got that itchy feelinglike they were discouraging banks
to working with, with borrowersto really, if there's any type of
(16:47):
decrease to get them through that, butmake sure they're still performing.
Evan Sparks (16:51):
Yeah, that's you know, that, that makes a lot of sense.
The you know, you're, if regulatorsaren't, aren't nervous about this,
if there's, you know, if you,it, it seems like there's a kind
of a, a much ado about nothing.
And honestly, a bit of a,an effort to kind of create
something, something that's.
You know, fabricates somekind of a little bit of drama.
(17:13):
That's actually not borneout by the data here.
Sharon Whitaker (17:16):
Yeah.
And I think there's a fear,you know, that, that the
valuations could, could plummet.
Central business district hashad their issues, but, you know,
I think it's almost a bit of a ringingthe bell, scaring a little bit ahead
of time before it perhaps could happen.
Evan Sparks (17:34):
And it certainly, if we, as we've talked about previously on
this show and, and in your, your, yourABA databank pieces, you know, the.
Community banks and mid sized banks inparticular have very minimal exposure
to some of these CBD sectors and you'remeanwhile you have a lot of exposure to
CRE sectors that are performing extremelywell like industrial and data center and
(17:55):
hospitality and all kinds of other sectorsthat you know doing great right now.
So this was really helpful.
Any final thoughts before we beforewe close off the close the discussion?
Jeff Huther (18:05):
The commercial real estate weaknesses are not hidden.
So it, and they've been around sincethe both the pandemic and then,
you know, with the second hit oninterest rates increases in 2022.
So, you know, we're now almost twoand a half years past that three
years past the, the, the last shockto the sector, and people have had a
(18:28):
lot of time to kind of think through.
How to deal with this and what theimplications are for for for credit risk.
So you know, I'd say we're we'rewe're in a situation where extending
and print pretending and it'sjust not the right right way to
describe the condition and mark.
All right.
Evan Sparks (18:50):
Well, thanks for being on the show with us today.
Thanks to R&T Deposit Solutionsfor sponsoring this episode.
You can find the the essay byJeff and Sharon and our, and our
colleague Dan Brown on a at aba.
com slash banking journal.
Thanks so much for listening.
And we'll be back withyou again, very soon.
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