Rising loan modifications signal mounting challenges for commercial real estate (CRE) lenders, as the traditional “extend-and-pretend” approach faces increasing limits.

Modification Trends:

Banks have significantly increased modifications on non-owner-occupied (NOO) CRE loans, with a 65-basis-point rise in the first nine months of 2024—a 35% jump since mid-year, according to Moody’s. Smaller banks led the charge with the sharpest percentage increase:

• Small Banks (<$100B in assets): Saw a 217% surge in modifications, climbing from 10 to 32 basis points, though their overall share remains relatively small.
• Mid-Sized Banks ($100B–$700B): Posted the largest volume of modifications, with a 61% increase from 120 to 193 basis points.
• Large Banks (>$700B): Experienced a modest 14% rise, from 69 to 79 basis points, indicating greater stability compared to smaller institutions.

No More Delays:

The “extend-and-pretend” playbook, used for years to avoid distressed asset sales in tight credit markets, appears to be losing effectiveness. Office CMBS loan delinquencies hit 11.2% in November 2024, tripling since early 2023, with forecasts suggesting they could surpass 14% in 2025. Multifamily properties are also under pressure due to increasing expenses and slowing rent growth.

Distressed Sales on the Rise:

More lenders are opting for distressed asset sales, often accepting significant losses. Moody’s reports seven such transactions between April and August 2024, each resulting in losses exceeding $100 million—up from just two in 2023. While high-quality assets can still attract private capital, deals come with steep costs due to today’s elevated-risk environment.

Broader Financial Risks:

The Federal Reserve Bank of New York warns that pushing loan maturities into future years could amplify systemic risks, potentially triggering sudden financial shocks. Additionally, these tactics have reduced new debt origination, cutting off capital for new development projects that could stimulate growth.

Key Takeaway:

Loan modifications have postponed immediate distress, but the runway for extend-and-pretend strategies is shrinking. As delinquencies climb and distressed sales accelerate, 2025 could bring market corrections—and opportunities for investors prepared to navigate a shifting CRE debt landscape.