A Loan Crisis Looms for Commercial Property - OZY | A Modern Media Company

By Robert Armstrong

  • Poorly rated debt is piling up at America’s biggest banks thanks to a coronavirus-damaged commercial real estate market.
  • Banks say these loans won’t all go bad, and they are still well-protected by property values — albeit values that are pre-pandemic.

U.S. banks are increasingly worried about being repaid on loans secured against commercial property, as offices, malls and hotels continue to stand empty.

The darkening outlook of banks is laid bare by disclosures on so-called criticized loans, which are flashing warning signals about a borrower’s ability to pay.

Among the 10 banks with the largest increases, criticized loans rose by 62 percent in aggregate in the second quarter, but criticized commercial real estate loans rose by 144 percent, to $26 billion, according to an analysis by the Financial Times.

The banks with the largest total increases include JPMorgan Chase, Bank of America and Wells Fargo, three of the four largest banks in the U.S. by assets. Criticized loans at those banks are now equivalent to 9, 13 and 25 percent of tier one equity capital — the core measure of a bank’s financial strength — respectively, according to S&P Market Intelligence.

The banks are betting hard that they will be fine because the loan-to-value ratio is [say] 50 percent. But the problem is, that was the loan-to-value from January.

Brian Foran, regional bank analyst at Autonomous Research

“People are looking pretty closely at criticized loans, particularly CRE loans. Because they’ve looked around the city and noticed it’s pretty empty,” said Brian Foran, regional bank analyst at Autonomous Research. 

A criticized loan is considered the equivalent of debt rated CCC or lower by a credit agency.

The dollar value of criticized loans jumped 42 percent across the U.S. banking sector as a whole in the second quarter, according to data gathered by Morgan Stanley. U.S. banks have added $111 billion to their loan loss reserves since the beginning of the year, according to the Federal Reserve.

The financial consequences of shutting swaths of the U.S. economy to deal with the coronavirus are still just becoming clear, as many hotels remain empty, shopping mall traffic is subdued and office workers remain at home. After many tenants skipped rent payments, some commercial landlords are struggling to make mortgage payments at a time when the future profitability of their properties is in doubt.

Bankers emphasize that falling into a high-risk category does not necessarily mean that a loan will go into default or even become delinquent — and that even in the case of default, banks can be made whole if the loan is collateralized by a valuable property.

“The banks are betting hard that they will be fine because the loan-to-value ratio is [say] 50 percent,” said Foran. “But the problem is, that was the loan-to-value from January.”

The largest increase in criticized loans was at Buffalo-based M&T Bank, where almost 40 percent of its loans are in commercial real estate, with a concentration in New York City.

Criticized loans at M&T soared 156 percent in the quarter and criticized CRE loans at the bank almost quadrupled, to $3.2 billion. Criticized loans are now equivalent to 55 percent of M&T’s tier one capital.

The case of M&T shows the challenges in comparing results from different banks, however. M&T made the decision to automatically downgrade the loans of any borrower who received payment forbearance during the crisis. “I don’t know of any other bank that did it that way,” one bank analyst said.

Another layer of complexity is added by recent adoption of the “current expected credit losses” accounting standard, under which banks must estimate losses for the whole life of a loan. This requires multi-factor economic modeling, rather than the simple monitoring of current loan performance. Different banks use different models.

“With judgment driving reserves, not trends in credit, you get these disconnects between reserves and criticized loans, and from bank to bank,” the bank analyst said. “Take a bank like M&T — they say they are being proactive, but from the outside, you really have no idea.”

Investors are not taking any chances. M&T shares have fallen 38 percent since February, about 10 percentage points more than U.S. bank indices.


OZY partners with the U.K.'s Financial Times to bring you premium analysis and features. © The Financial Times Limited 2020.

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