Storefronts and hotels closed by home orders are a nightmare for workers, business owners, and their landlords. But so far it’s just a very bad dream for bankers.
Commercial real estate loans that finance shopping malls, warehouses, offices and other commercial real estate are a significant part of banks’ portfolios, accounting for about 22% of their total loans, according to Evercore ISI. A large part of this, around 17% of the total loans, is for non-owner-occupied real estate.
After building reserves in the second quarter, large banks that released CRE loan numbers now have loan loss allowances averaging 2% of those loans, according to Autonomous Research. This corresponds to an allowance of around 11% of the credit card loans at large banks with these loans.
Card loans that are unsecured and given to a range of consumers tend to have much higher rates of loss than commercial real estate loans. But even with that factored in, banks seem relatively confident about commercial mortgages. Their write-downs on these loans account for about a third of the Federal Reserve’s projected losses in the 2020 stress test. In the case of consumer loans, bank allowances are now just under two-thirds of the Fed’s forecast loss rate.
According to the accounting and regulatory requirements Banks have to project losses before they occur they usually use models based on economic inputs. To date, card arrears and losses have been largely falling thanks to a combination of government economic reviews, unemployment benefits, and lender forgiveness programs.
There are already burdens in commercial real estate lending. Some banks have found that portions of their loans that have been newly classified as non-accrued were for real estate such as shopping malls and hotels. Early warning signs are also emerging in the commercial mortgage-backed securities market. According to Trepp, a real estate investment data and analytics firm, the June default rate on CMBS home loans, measured 30 days after maturity or beyond, was 10.32%, just below the 2012 high. The rate dropped to 9 in July. 60%.
Investors could view this as a test case of what would happen if support measures were put in place were more limited by the credit market. A survey by the American Hotel & Lodging Association in May found that 91% of borrowers with bank loans sought and received relief, but only 20% of borrowers with CMBS loans.
The two markets are not strictly analogous. For one, bank loans tend to have a lower credit-to-value ratio. Wells Fargo’s chief financial officer, John Shrewsberry, told analysts in July that “the bank’s actual performance is very different from CMBS.” Bank lenders have additional recourse beyond collateral and plenty of options to adjust troubled loans. He said, “We’re working these things through, borrower for borrower. … It’s not much of a panic at this point in the cycle.”
The key question will likely be whether the deferrals will allow time for borrowers on the threshold to resolve problems.
In July, analysts said exposure to commercial real estate was relatively underweight and noted the “likelihood” [CRE] will be quite exposed during this downturn. “The bank said the percentage of deferred commercial mortgage loans at the end of June was 16%, the highest of their loan categories. However, it was also noted that no borrowers in commercial loan categories had applied for a second 90-day grace period.
A regional lender with a sizable commercial real estate business in New York City said indulgence requests did not increase in the second quarter from the first quarter. The problems were also concentrated in troubled sectors. The rental income for industrial real estate was still around 95% and for apartment buildings and offices around 90%. In retail, the rental rates are lower, but improve from around 30% in April to over 50% in July. While it is “too early to declare victory,” the executives said, “trends did not deteriorate from the beginning of the quarter through the end of the quarter and are arguably a little more positive.”
However, with more retailers appearing to go bankrupt every week and the future of office work is in the air, commercial real estate needs to be watched closely by bank shareholders.
Write to Telis demos at [email protected]
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