New York Fed identifies hidden risks in home loans By Investing.com

The Federal Reserve Bank of New York released a report today revealing that banks changed the terms of commercial real estate (CRE) loans to hide potential losses, which pose a threat to the financial system. The CRE sector has struggled since the pandemic, with demand for office space falling due to remote work and lockdowns. Despite these challenges, the sector has yet to show signs of significant recovery.

The report says that since the spring of 2022, banks have engaged in a practice known as “extension and pretend,” where they extend the terms of impaired CRE mortgages to avoid principal writedowns. This has led to credit crunch and increased financial vulnerability. The authors of the study warned that problems with this type of loan could appear quickly.

Federal Reserve officials expected some manageable problems among banks with CRE loans, expecting the problems to be small, mostly affecting smaller banks and growing gradually. Despite this, the market in general has not seen major disruptions so far, with non-performing loans and net losses remaining low, particularly among less capitalized banks.

Banks hold the majority of the $5.8 trillion CRE loan market, with 50.7% of those loans in the final quarter of 2023. The report indicates that banks with lower capital levels, due to loss of security portfolios, more likely to extend loan terms. These extensions made it difficult to originate new CRE loans and increased the likelihood of a “maturity wall,” where a large number of loans could mature at the same time, potentially leading to significant losses.

The study found that CRE mortgages from thinly capitalized banks are slightly more likely to extend their terms compared to those from better capitalized institutions. However, the Federal Reserve’s rate cuts that began in September, and are expected to continue, may provide some relief to the CRE loan market.

In related news, Moody’s upgraded its outlook on the banking sector to stable on Monday, citing the shift to stabilizing asset quality due to rate cuts, particularly for CRE loans. . In addition, a report from Goldman Sachs (NYSE:) from the end of September showed that although the CRE loan market is growing at a slower pace, there is little evidence of a credit crunch in the sector.