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CRE loan distress: Spot the symptoms, diagnose, and treat problem loans

Jason Alpert
March 13, 2024
Read Time: 0 min

How to respond to commercial real estate loan distress

Use these tips for banks and credit unions to identify and handle commercial real estate loans that are showing signs of being problem CRE credits.

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Protecting portfolio health

Ailing commercial real estate loans?

Media organizations are reporting scary-sounding data, and the headlines scream about the most recent victims. Government entities are issuing advisories and guidance for addressing this unfamiliar phenomenon and for shielding the financial institution from the potential threat. Individuals and business owners are starting to contemplate the worst-case scenario and how it can impact their earnings and balance sheet.

Is the above scenario another pandemic akin to our recent COVID experience? No, it’s the current situation in the commercial real estate (CRE) market tied to the threat that distressed properties and problem CRE loans pose to investors, banks and credit unions, and the economy at large.

While no potential CRE “disaster” is comparable to the COVID pandemic in terms of the human impact, it is still a clear and present danger to our banking system and the economy.

CRE is now arguably the riskiest asset class due to a perfect storm of:

  • Systemic changes in the way we utilize real estate (not just office, but retail, housing, and other sectors).

  • Unprecedented increases in interest rates from an abnormally historic low-rate environment.

  • Inflationary impacts on costs of various inputs.

  • A wave of pending maturity events ($2 trillion of CRE loans are reported to mature in the next years).

Consequently, all stakeholders of CRE assets are understandably nervous, including bankers and their investors who, due to the highly leveraged nature of CRE transactions, provided the bulk of capital financing the industry.

Bank and credit union leaders who recognize souring CRE loans with the potential to manifest like an illness in their institutions should engage their workout professionals/team. Doing so is akin to taking a relative to the doctor when sick or showing symptoms. The workout team can help lenders diagnose distressed CRE assets. Workout specialists can also provide consulting and advice (treatment) that either helps alleviate the loans’ distress (symptoms) and restore them to health or helps mitigate the spread of the “illness” to protect the health of the financial institution.

Here’s how banks and credit unions with strong CRE risk management can identify weakening property loans, assess them, triage them, and assist with their prognosis and treatment.

You might also like this podcast on leveraging the Fed's stress test scenarios.

Early symptoms

Signs of potentially troubled CRE loans

Given the heightened and well-established risks that commercial real estate loans pose, banks and credit unions should be on high alert for any signs of sickness in their CRE portfolio. In this environment, any indication of early warning signs of distress from a CRE loan should be addressed immediately. Bring together the deal team, credit approvers, and workout experts to discuss and determine the grade and next steps.

Beyond a hard money default due to a payment or maturity event, early warning signs for commercial real estate loans typically manifest as a:

  • Failure to pay real estate taxes.
  • Failure to sustain adequate insurance coverage.
  • Failure to maintain the property.
  • New lien on the commercial real estate.
  • Failure to deliver required financial information.

Each of these signs is a major commercial real estate red flag as it represents a lack of cash and resources to pay required obligations, mitigate catastrophic risks, and support value. Furthermore, failure to pay taxes and insurance is almost always an event of default, and the mortgage instrument provides the bank or credit union the ability to advance funds and force-place insurance to protect the collateral.

Additionally, any new liens on the property demonstrate cash flow issues with the property, especially if the financial institution was notified as required under the loan documents.

Finally, any failure to deliver required financial information in a timely manner (including rent rolls/operating statements) or any covenant defaults (e.g., debt service coverage, debt yield requirements, or loan-to-value maximums) all represent major issues with respect to the loan. They should be addressed immediately. Ignoring any actual defaults is unacceptable and creates liability for the bank or credit union because this “course of dealing” can be interpreted as the institution waiving its rights. The bank or credit union can even lose the collateral (in the event of a tax deed sale or casualty event with no insurance coverage).

Learn more about managing CRE loan distress. Watch this webinar on problem loans and how to identify them quickly with data and reports.

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Take timely action

Diagnosing next steps for problem commercial real estate loans

As stated above, once an early warning sign for a distressed commercial real estate loan is identified, there is an increased probability of future non-performance, or if an event of default occurs, it is imperative that the bank or credit union take appropriate and timely action. What should the institution do? Here are three actions to take:


Engage CRE credit partners

The institution’s deal team should engage with their credit partners and determine if the CRE loan should be downgraded and more closely monitored.

Engage the workout team

If there is an actual event of default or a hard money default that cannot be resolved (missed payment(s) or maturity event that doesn’t meet renewal policy), the deal team and credit approvers should engage the workout team for consultation and discussion. At this point, with the workout team involved, a diagnosis of the commercial property loan can be made as to the appropriate steps in protecting the financial institution and mitigating losses (either through further downgrades or even charge offs).

The workout team or expert will be able to approach the deal from an independent viewpoint and provide important feedback to the deal team as to current risks, future problems, and prospective strategies. Most loan workout experts are not in the blame game with their bank or credit union counterparts and are providing credible challenges as to current assumptions in order to determine the best course of action for a troubled CRE loan (similar to a doctor not shaming the patient while advising the best course of treatment).

Consult on potential treatment

After discussions, the group might determine that the issue is a short-lived, one-time event, and a waiver of default is appropriate. On the other hand, they may decide a more long-term and intensive solution is necessary, including a formal workout shadow arrangement or a full-blown transfer to the workout team. The former is similar to a doctor prescribing medication to take at home, while the latter is more like outpatient therapy and admittance to the hospital. If the illness of the property credit is significant, then intensive care is needed, and workout should own the asset.

The benefit will be that the workout specialists will have an independent and objective relationship with the commercial property owner since they didn’t originate the deal. They have no preconceptions regarding the credit or the loan documents, and they also have experience in managing the riskiest of assets so they can forecast and strategize on the best course of treatment.

Appraisals and analysis

Triage CRE loans in workout

If the bank or credit union team determines that the commercial real estate loan should be moved to workout, or even if a formal consulting and shadowing relationship with workout is warranted, then the loan should be admitted to what’s essentially the financial institution’s emergency room. Typically, when a patient is admitted to the ER, vital signs are taken (current financial package), symptoms are closely observed (problems analyzed), new tests are ordered (new appraisals obtained and/or requests made for additional financial information), and the patient is asked probing questions to help in the diagnosis (interview with the borrower). A similar triage process and triage checklist can be administered in the case of CRE loan distress.


Reengage the deal team

The workout banker should reengage the deal team, especially the relationship manager who was working with the customer or member. Obtaining access to all of the loan documents and credit file is of paramount importance and the relationship manager can provide context and share any important email, correspondence, and servicing notes with the customer or member. At this point, the workout officer will conduct a full and comprehensive review of the loan documents (which are essentially the Bible governing the loan), including email correspondence, letters, or other documentation that may provide a “smoking gun” indicating lender liability or a commitment made about the loan (either directly or inadvertently). If there are weaknesses in the loan documentation or if any lender liability is discovered, the workout officer should engage legal partners and craft a strategy on how best to resolve it, first and foremost. The financial institution may also want to engage a lawyer to formally review the loan documents and title to verify there are no gaps or insecurities.

Meet with the borrower

A meeting should occur with the borrower to introduce the loan officer and workout officer (warm handoff – if possible) – hopefully at or near the collateral property. Note: I am a firm believer that a commercial property inspection must be conducted by the credit union or bank or its officer if possible. The on-site inspection can illuminate any issues with the neighborhood or the property itself (e.g., unreported vacancies, visible deferred maintenance, and busyness of the property).

Some best practices for this initial meeting with the borrower, which can be contentious if the customer or member has never been sent to workout, are to:

  • Have two bank or credit union representatives at the meeting.
  • Take good notes and minutes.
  • Email those minutes to all attendees to recap the discussion.

Often, workout meetings can be difficult discussions, and if emotions run high or the borrower makes accusations, it is best to have a record of what was discussed. It is important to note that the introductory meeting will not resolve the issues but is more for explaining the role of the financial institution, the rules of the road for communication going forward, the issues that predicated the transfer, and to make requests for additional information needed (financial and otherwise) that will be necessary to work on a solution. Again, follow up in writing with the formal request for information, and be sure to include any and all parties to the loan (including co-borrowers and guarantors).

Re-underwrite the CRE credit

The loan workout team will essentially want to re-underwrite the commercial real estate credit, especially if the borrower is open and transparent in providing updated financial information (both current and projections). It is also at this point that the bank or credit union should obtain an updated third-party appraisal of the collateral, especially if the last appraisal on the real estate or other collateral is stale (older than 12 months old) or if there have been substantial changes to the property or surrounding market. Additionally, if the loan documents allow or if the loan has an actual declared default, the institution should obtain updated financial information from all guarantors (corporate and personal).

Revisit the loan grade

Once all of this information has been obtained on the primary, secondary and tertiary sources of repayment, the bank or credit union can revisit the current grade on the distressed CRE loan and strategize on the best course to resolve the asset. The financial institution should make the distinction of whether the credit is a “retain” or “exit” customer or member. The former indicates a strategy of rehabilitation and return to line of business. The latter indicates a collection posture that seeks to get repaid via the strategy that provides the best resolution on a net present value basis.

Go-forward strategy

Make a prognosis for the CRE credit

Once the workout team has developed its recommendation and strategy for the problem CRE loan, it should follow up with the deal team to share findings and explain the go-forward strategy with the credit, i.e., the manner and course of treatment as to the patient.

If the deal team has reservations or wishes to provide a credible challenge, they should feel free to do so, as it is important that the entire bank or credit union team be on board with the ultimate strategy for the credit. Note, however, that the workout team must hold the ultimate decision. The workout group will want to keep its business partners in the loop as the deal and negotiations develop, especially in cases where the customer or member is politically or socially sensitive. It may be important to have a media relations or legal representative aware in the event any media inquiries are made regarding the CRE asset.

In essence, the workout team should be clear and deliberate in achieving its strategic objectives with respect to resolving the asset. Loan workout is not always a straight journey between diagnosis and the ultimate cure, as is the case with many medical treatments. The problem may be a chronic condition, or there may be many iterations, stop-and-starts, relapses, and even “death” via bankruptcy/liquidation. However, if the workout team follows the example set by the medical field’s principle of “First, Do No Harm” and follows a strict ethical path to achieving its desired resolution, the financial institution’s stakeholders will ultimately be best served.

Struggling to track and report on construction loans? Learn how Heritage Bank cut days off its processes.

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About the Author

Jason Alpert

Managing Partner
Jason Alpert is Managing Partner of Castlebar Holdings, a distressed debt investor and consultant to financial institutions. He is a 20-year workout banker with extensive experience running special assets departments and overseeing the sale of over $1 billion in commercial loans to the secondary market. Reach Jason at 813-293-5766, [email protected], at,

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