At the largest US banks, bad commercial real estate loans have surpassed loss reserves, spurred by a significant uptick in late payments associated with offices, shopping centers, and other properties.
Surge in Delinquent Commercial Real Estate Loans
According to filings with the Federal Deposit Insurance Corporation, the average reserves at JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs, and Morgan Stanley have decreased from $1.60 to 90 cents for every dollar of commercial real estate debt where a borrower is at least 30 days overdue.
This sharp decline occurred over the past year, with delinquent commercial property debt for the six major banks nearly tripling to $9.3 billion.
In the broader US banking sector, the total value of overdue loans associated with offices, shopping centers, residential complexes, and other commercial properties surged last year, reaching $24.3 billion, compared to $11.2 billion the previous year.
FDIC data reveals that US banks currently maintain $1.40 in reserves for every dollar of delinquent commercial real estate loans, a decrease from $2.20 a year earlier.
This marks the lowest level of coverage that banks have had to mitigate potential losses from commercial real estate loans in over seven years.
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Decline in Reserves at Major US Banks
Earlier this month, New York Community Bank experienced a drastic drop of over 50% in its market value following the revelation of hundreds of millions of dollars in previously undisclosed potential losses within its commercial property loan portfolio.
The crux of the matter revolves around loan allowances, also known as reserves, which banks set aside to anticipate future losses due to delinquencies.
These provisions directly impact earnings, prompting banks to strategize ways to minimize their impact.
Implications of Drastic Drops in Market Value
Traditionally, banks and regulators establish allowances based on loan categories and historical loss rates.
For instance, banks typically allocate higher allowances, such as 10%, for unsecured lending like credit card loans, compared to 2 or 3% for commercial real estate loans, which historically have lower default rates.
However, some argue that relying solely on historical loss rates for commercial properties, especially offices, in light of the COVID-19 pandemic could be risky.
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Debate Over Loan Allowances Amid Pandemic
They advocate for banks to base reserves on current levels of delinquencies instead.
In December, Bank of America’s CEO, Brian Moynihan, stated that the bank had pinpointed only $5 billion in commercial property debt linked to sectors of the property market where prices had declined.
He characterized this amount as insignificant for a bank that generated nearly $30 billion in earnings last year and holds assets exceeding $3.2 trillion.
In conclusion, the increasing burden of bad commercial real estate loans, coupled with depleted reserves, poses significant challenges to the stability of major US banks.
As the debate over loan allowances intensifies, the banking sector faces pressure to reassess risk management strategies to mitigate potential losses and ensure financial resilience.
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Dean is a freelance content writer who contributes to various Digital Media Companies and independent websites all over the world. He has over 20 years of financial industry experience, so it’s safe to say he’s well informed.