REAL ESTATE NEWS

BIG BANKS ARE LOW ON RESERVES FOR DELINQUENT CRE LOANS

Published on Wednesday, February 21, 2024

The drop happened during the last year, even as regulators focused on potential CRE loan losses.

 

It’s commonly known that commercial banks are facing pressures from commercial real estate loans. Difficulties in refinancing because of higher interest rates, sinking valuations, and falling demand for space because of hybrid work, meaning lower revenue, all of which could turn into trouble for lenders.

But the problem is becoming a lot deeper. According to the Financial Times, the amount of bad property debt is higher at big banks than their existing reserves against it. “The average reserves at JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley have fallen from $1.60 to 90 cents for every dollar of commercial real estate debt on which a borrower is at least 30 days late, according to filings to the Federal Deposit Insurance Corporation,” they wrote.

The numbers are average and vary wildly among the banks. The CRE coverage ratio was close to the same in 2022 and 2023 for JPMorgan Chase and remains close to 3.0. But for each of the other banks, the ratio is below 1.0. Citigroup and Goldman Sachs were each below 0.5. Goldman was the only bank whose CRE coverage ratio was higher in 2023 than in 2022.

Reserves against potential loss are subtracted from earnings and so companies like banks have an incentive to take fewer rather than more reserves.

The Federal Reserve has had concerns about how banks have been handling CRE loans, according to a speech by Michael Barr, vice chair for supervision at the Fed.

“The reduced demand for office space and higher interest rates have put pressure on some CRE valuations, particularly in the office sector,” Barr said. “Supervisors have been closely focused on banks' CRE lending in several ways: how banks are measuring their risk and monitoring the risk, what steps they have taken to mitigate the risk of losses on CRE loans, how they are reporting their risk to their directors and senior management, and whether they are provisioning appropriately and have sufficient capital to buffer against potential future CRE loan losses.”

Barr also said that the Fed has “issued more supervisory findings and downgraded firms' supervisory ratings at a higher rate in the past year.” The central bank has also increased issuance of enforcement actions as a reflection of “the changing economic, interest rate, and financial environment on a bank's financial resources.”

Banks are also facing the prospect of needing to keep more capital on hand because of new regulations implementing the international Basel III requirements. That would further reduce earnings because it can't be used in other ways like investment to generate profit.