US Office Loan Pain Is Only Starting to Ramp Up

(Bloomberg) — Any hopes that falling borrowing costs would stem the pain from the US office downturn were swept away this week.

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Deutsche Bank AG set aside more money for souring US commercial real estate loans, while a Blackstone Inc. mortgage trust slashed its dividend. New York Community Bancorp’s shares then plunged the most since the last bout of CRE-related turmoil in March after provisions for losses came in at more than double the average expected by analysts.

The announcements signal that lenders may not be able to just amend and extend loans in the hope that lower interest rates will ease borrowers’ pain and give property owners more time to refinance debt. More than $94 billion of US commercial real estate is currently distressed, according to MSCI Real Assets, with a further $201 billion at risk of slipping into that category.

“As a $1.5 trillion wall of loan maturities hits over the next two years, the implications are profound,” John Murray and François Trausch at Pacific Investment Management Co. wrote in a note this week. “Lenders and borrowers will be forced to ‘face the music’: In the near term, we expect further declines in appraised valuations and price indices, making loan extensions even more difficult to rationalize.”

The bad news began when Deutsche Bank said the office sector in the US will continue to impact earnings in the coming months, although it expects CRE provisions to be lower in the second half. Later that day, Blackstone Mortgage Trust Inc., a target for short sellers, reported a quarterly loss to the trust of $61 million compared with a $101.7 million profit in the same period a year earlier. It cut its dividend by 24%.

The following day, New York Community Bancorp said it set aside another $390 million during the second quarter to cover loan losses, primarily due to office lending.

“Higher impairments suggest asset revaluations may still be working their way through at lenders and others with real estate exposure,” said Tolu Alamutu, a senior credit analyst at Bloomberg Intelligence, of the outlook for the industry. “As transaction volumes creep up, more adjustments can’t be ruled out. These marks may pale in comparison to last year’s but may still reverberate.”

Credit investors remain comfortable that the turmoil from CRE will be contained, with risk premiums on bank bonds rising less than the broader market, showing they’re outperforming.

Private Credit

Private credit providers see an opportunity to profit as borrowers approach maturity walls. CRE debt funds are seeking to raise about $50 billion in capital over the near term, with some considering the purchase of impaired loan portfolios from banks, according to researcher Green Street.

Katie Keenan, Blackstone Mortgage Trust’s chief executive officer, said in a statement, “With strong liquidity, accelerating repayments, and an emerging investment pipeline, BXMT is well positioned to deploy capital accretively in this environment and continue its forward trajectory through the cycle.”

There are opportunities for investors in both senior and mezzanine debt, Murray and Trausch at Pimco wrote, though they cautioned that the CRE damage will be long lasting even if the Federal Reserve begins to loosen monetary policy.

Forward curves suggest borrowing costs will keep business property values 20% to 40% below their 2021 high, they said, adding that “the headwinds buffeting the commercial real estate market will result in a materially slower recovery than that seen after the global financial crisis.”

Week in Review

• Blue-chip companies sold bonds in the US this month at the fastest rate for any July in seven years, harnessing strong demand from investors looking to lock in high yields before the Federal Reserve starts cutting rates.

• Money managers including Pacific Investment Management Co., fed up with ultra-expensive corporate bonds and wary of economic risks, are pouring money into mortgage debt. A fast-approaching Fed rate cut would only sweeten the deal.

• Some money managers are vowing to never again back a series of European billionaires, including Patrick Drahi, as the moguls enter bruising negotiations with creditors to help save their struggling empires.

• Sales of panda bonds jumped to a record $17 billion so far this year, as foreign borrowers piled into China’s onshore market in search of cheaper borrowing costs.

• The massive debt pile loaded onto Thames Water Ltd is teetering on the edge of junk, following S&P Global Ratings’ warning of a downgrade.

• Apollo Global Management Inc. and a group of banks led by Bank of America Corp. and Barclays Plc have been holding restructuring talks for a slug of Brightspeed debt that could see the banks take a loss.

• Varta AG’s creditors including RBC BlueBay Asset Management are in talks with Porsche AG to join forces on a restructuring deal for the embattled battery maker.

• A group led by Morgan Stanley is providing a roughly $2 billion debt package to help finance KKR & Co.’s acquisition of educational software provider Instructure Holdings Inc.

• JPMorgan Chase & Co. is sounding out investors on a potential high-yield bond sale by Walgreens Boots Alliance Inc. to address the recently downgraded drug-store chain’s near-term debt maturities.

• Europe’s collateralized loan obligation market is set for a record year of issuance, and a flurry of new entrants are looking to get involved in the upturn.

• The Carlyle Group and CVC Credit are leading a roughly €600 million ($651 million) private loan package for KKR & Co.’s purchase of music festival organizer Superstruct Entertainment.

• The private equity owners of Foundation Consumer Healthcare, the company behind popular morning-after pill Plan B One-Step, are in early talks with lenders to explore options that include refinancing debt.

• Marathon Asset Management was a main holder of AMC Entertainment Holdings Inc. loans that are being swapped under a debt restructuring plan and give those investors a new claim on US theaters.

On the Move

• Citadel Securities has added Matthew Perez and David Kashetta to its credit sales team as it grows its investment-grade bond business. They join from HSBC Holdings and Goldman Sachs Group Inc., respectively.

• HPS Investment Partners has recruited Jeff Boswell as managing director in alternative credit. He joins from asset manager Ninety One, where he was head of alternative credit.

• HSBC Holdings Plc hired Andrew Layng from Jefferies to join its US credit team as head of financials trading.

• Bank of America Corp. has named Eddie Martin as head of EMEA leveraged finance. He is replacing Rahul Srinivasan, who is joining Spanish pharmaceutical company Grifols SA as CFO.

• Former Deutsche Bank traders Ben Doramus and Luke Doramus have set up a new investment firm. D2 Asset Management LP will specialize in real assets, specialty finance and structured credit, in partnership with an investment arm of the Koch network of companies.

• Sona Asset Management has tapped Malay Patel for its structured product investing team. Patel left D.E. Shaw earlier this summer.

• Citi has appointed Ed Huntsman as head of financing, markets for Japan, Asia North and Australia, and Asia South.

• Capital Group has hired Pimco’s Álvaro Peró Gala as fixed-income investment director.

–With assistance from James Crombie and Tasos Vossos.

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