Bad debt exceeds reserves at largest US banks

US banks now hold $US1.40 in reserves for every dollar of delinquent commercial real estate loans, down from $US2.20 a year ago, according to the FDIC data, and the lowest cover banks have had to absorb potential commercial real estate loan losses in more than seven years.

Bill Moreland of BankRegData, which collects and analyses lender data, said that across the industry there was little doubt that “allowances for these loan losses have to come way up”.

“There are banks that may have looked fine six months ago, that are going to look not so good next quarter,” Mr Moreland said.

Earlier this month New York Community Bank shed more than 50 per cent of its market value after reporting hundreds of millions in previously undisclosed potential losses in its commercial property loan book.

The issue centres on loan allowances — or reserves — which are the provisions banks take to cover future losses on delinquencies. Provisions are a hit to earnings, so banks seek to limit how and when they take them.

Traditionally, banks and regulators set allowances by loan category and historical loss rates. Banks hold higher allowances — for example, 10 per cent — for unsecured lending such as credit card loans, compared with 2 or 3 per cent for commercial real estate loans, which have lower default rates.

Some argue that relying on historical loss rates for commercial properties — particularly offices — in the wake of the COVID-19 pandemic may be risky, however, and that banks should instead be basing reserves on current levels of delinquencies.

“At some point if high vacancy rates hold, these property owners are not going to be able to service their debts, and banks are going to foreclose,” said João Granja, an accounting professor at the University of Chicago’s Booth School of Business.

“I know that the historical loss rates are low, but we need to see if the banks have been forward-looking in predicting expected losses, and not just relied on what has happened in the past.”

Bankers say they are prepared. Their reserves against delinquencies were higher than needed a year ago, and are now being drawn down as delinquencies rise, they say. They argue that regulators appear to be focused on small and mid-sized banks’ exposure.

Bank of America’s chief executive Brian Moynihan said in December that the bank had identified just $US5 billion in commercial property debt tied to buildings in sectors of the property market in which prices had dropped, a figure he said was tiny for a bank that earned nearly $US30 billion last year and has more than $US3.2 trillion in assets.

“It’s such a small part of the table,” Mr Moynihan said. “We feel good.”

This month, however, BofA said in an FDIC filing that delinquencies on loans tied to office, apartment and other non-residential buildings had jumped 50 per cent in the final quarter of last year to $US2.1 billion. At the same time, the bank cut its loss reserves for those loans by $US50 million to just under $US1.3 billion.

Richard Barkham, global chief economist at commercial real estate firm CBRE, said that in the industry, “any downturn in provisions . . . would fundamentally be the wrong behaviour”. Banks could lose as much as $US60 billion on soured commercial real estate loans in the next five years, he estimated — about double the $US31 billion they have reserved for those loan losses, according to BankRegData.

Financial Times