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Delinquent payments related to offices, shopping centers and other properties have soared, causing bad commercial real estate loans to exceed the loan loss reserves of major U.S. banks.
Average reserves at JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co., Citigroup Inc., Goldman Sachs Inc. and Morgan Stanley fell to 90 cents on every dollar of commercial real estate debt where borrowers are 30 days or more late, from $1.60, according to filings with the Federal Deposit Insurance Corp.
The sharp deterioration came last year, when delinquent commercial real estate debt at the big six banks nearly tripled to $9.3 billion.
Michael Barr, the Federal Reserve's head of banking oversight, said Friday that regulators are “looking closely at banks' real estate lending,” including how they report risks internally and whether “they have built up adequate reserves and have sufficient capital to mitigate potential future real estate lending losses.”
Across the U.S. banking industry, the value of delinquent loans tied to offices, shopping malls, apartments and other commercial properties more than doubled last year to $24.3 billion from $11.2 billion the year before.
U.S. banks currently hold reserves of $1.40 for every dollar of delinquent commercial real estate loans, down from $2.20 a year ago, according to FDIC data, bringing the reserves banks take on to absorb potential losses on commercial real estate loans to the lowest level in more than seven years.
There's no question that the industry as a whole “needs to significantly increase reserves for these loan losses,” said Bill Moreland of BankRegData, which collects and analyzes lender data.
“Banks that were OK six months ago will be in a less-than-good position next quarter,” Moreland said.
Earlier this month, the New York community bank lost more than 50% of its market capitalization after reporting hundreds of millions of dollars of previously undisclosed potential losses on its commercial real estate loan book.
The problem centres on loan provisions, or reserves, that banks take to cover losses from future delinquencies. Because provisions hit earnings, banks are trying to limit how and whether they can be taken.
Traditionally, banks and regulators set reserves according to the loan category and historical loss rate. Banks set higher reserves (say 10%) for unsecured loans such as credit card loans, but 2% to 3% for commercial real estate loans because of their lower default rates.
But some argue that relying on historical loss rates for commercial real estate, especially offices, is risky in the wake of the COVID-19 pandemic, and that banks should base their reserves on current delinquency levels.
“If vacancy rates remain high, at some point property owners will not be able to repay their debts and banks will have to foreclose,” said Joan Granja, a professor of accounting at the University of Chicago Booth School of Business.
“We know that historical loss rates have been low, but we need to see whether banks have been looking forward and forecasting expected losses rather than just relying on what has happened in the past.”
Bankers say they are prepared: Their delinquency reserves were higher than they needed a year ago but are now being drawn down as delinquencies rise, they say, and they argue regulators seem to be focusing on the risks to smaller banks.
Bank of America Chief Executive Brian Moynihan said in December that the bank had just $5 billion in commercial real estate debt tied to buildings in sectors of the market that have seen prices fall, a paltry figure for a bank that made nearly $30 billion in profits last year and has more than $3.2 trillion in assets.
“That's just a small part of the table,” Moynihan said. “We're happy with it.”
But in an FDIC filing this month, Bank of America said delinquencies on loans related to offices, apartments and other nonresidential buildings rose 50% to $2.1 billion in the fourth quarter of last year. At the same time, the bank reduced its loss reserves for those loans by $50 million, to just under $1.3 billion.
“Reducing reserves is the fundamentally wrong thing to do” for the industry, said Richard Barkham, global chief economist at commercial real estate firm CBRE. He estimates that banks could lose up to $60 billion from bad commercial real estate loans over the next five years, nearly double the $31 billion they have set aside in reserves for such loan losses, according to BankReg data.
Video: Banks' worst year since 2008 | FT Films
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