U.S. banks have slashed loss reserves for commercial real estate loans to just 90 cents for every $1 of debt that is 30 days past due, representing an alarming drop in protective buffers at a time when delinquent commercial property loans have nearly tripled to $9.3 billion over the past year across the 6 largest banks.
Experts warn that banks are severely underestimating future losses by relying too heavily on low historical default rates rather than current market conditions and vacancy rates that point to significantly higher risks. The value of delinquent commercial real estate loans tied to offices, malls, apartments and other properties has more than doubled over the past year to $24.3 billion nationwide, while average bank reserves per dollar of such troubled debt have plunged from $2.20 to $1.40 over the same period.
“There is little doubt that allowances for these loan losses have to come way up,” said Bill Moreland of BankRegData, with many banks likely to show deteriorating health in upcoming earnings reports. The concerns center on loan loss allowances and provisions—hits to earnings—that banks seek to minimize even when risks are building.
While bankers argue historical performance justifies slim reserves and current exposure is limited, regulators are keeping an anxious watch as thinly protected loan books raise risks of bank distress amid a profoundly changed commercial real estate landscape. The Fed’s Michael Barr said supervisors “have been closely focused on banks’ CRE lending,” scrutinizing internal risk reporting and loss provisions.
With high office vacancy rates expected to drag down property values, banks may end up foreclosing on many loans they now consider performing. “At some point, if high vacancy rates hold, these property owners are not going to be able to service their debts,” said João Granja, an accounting professor at the University of Chicago’s Booth School of Business, who argued banks have not been “forward-looking in predicting expected losses.”
Some experts estimate banks could face up to $60 billion in commercial real estate losses over the next 5 years, about double what they currently have reserved. Yet bankers maintain optimism, with Bank of America CEO Brian Moynihan stating that shaky commercial property debt is a “small part” of the bank’s massive balance sheet. However, BofA itself reported a 50% jump in delinquent commercial real estate loans in its latest filing, even as it cut reserves by $50 million.
The data points to a dangerous gamble on commercial property exposures that could leave major banks underprepared for looming loan distress. Regulators are pushing banks to bolster their defenses before it’s too late, but lenders appear to be sticking with the devil they think they know.
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