Bad commercial real estate loans have overtaken loss reserves at the biggest US banks

Bad commercial real estate loans have become a concern at major US banks as late payments on offices, shopping centers, and other properties have surged. The average reserves at JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs, and Morgan Stanley have dropped from $1.60 to 90 cents for every dollar of commercial real estate debt where the borrower is at least 30 days late, according to filings with the Federal Deposit Insurance Corporation (FDIC).

This sharp decline occurred over the last year as delinquent commercial property debt for these six banks nearly tripled to $9.3 billion. Regulators, including Michael Barr of the US Federal Reserve, have been closely monitoring banks' commercial real estate (CRE) lending practices, focusing on how they report their risk internally and whether they have sufficient capital to buffer potential future losses from CRE loan defaults.

Across the broader US banking sector, the value of delinquent loans tied to offices, malls, apartments, and other commercial properties more than doubled last year to $24.3 billion, up from $11.2 billion the year before. Banks now hold $1.40 in reserves for every dollar of delinquent commercial real estate loans, down from $2.20 a year ago, according to FDIC data, the lowest coverage banks have had to absorb potential losses in more than seven years.

Bill Moreland of BankRegData, which analyzes lender data, believes that banks need to significantly increase their allowances for these loan losses. He stated that there are banks that looked fine six months ago but may not look as good in the next quarter.

One recent example is New York Community Bank, which saw more than a 50% drop in its market value after reporting hundreds of millions in previously undisclosed potential losses in its commercial property loan book.

The issue revolves around loan allowances, or reserves, which banks set aside to cover future losses on delinquent loans. These provisions are deducted from earnings, so banks try to limit how and when they take them.

While banks and regulators traditionally set allowances based on historical loss rates, some argue that relying on historical data for commercial properties, particularly offices, post-Covid-19, may be risky. They suggest that reserves should be based on current levels of delinquencies instead.

Bankers, however, assert that they are prepared for potential losses. They note that their reserves against delinquencies were higher than needed a year ago and are now being drawn down as delinquencies rise. Bank of America's CEO, Brian Moynihan, has expressed confidence in the bank's ability to manage these risks, citing a relatively small exposure to commercial property debt in sectors with declining prices compared to its overall earnings and assets.