Bank Losses Increase As Commercial Real Estate Tanks

Nov 12, 2020 | Economic Collapse

Buried in the fine print of Signature Bank’s third-quarter earnings was a hint of the financial storm that could be about to break over the U.S. economy.

The Manhattan bank last month set aside nearly $53 million to cover potential loan losses largely due to the coronavirus pandemic’s impact on the U.S. economy.

Lending money to shopkeepers, landlords and hoteliers in places such as Times Square or SoHo used to be considered almost a sure thing. But that was before the contagion emptied New York City’s skyscrapers, hotels, apartment buildings and stores, leading the president of the United States to call it “a ghost town” and forcing some borrowers to stop making loan payments.

Now Signature, which has nearly 60 percent of its portfolio tied up in commercial real estate, is bracing for the fallout. The bank’s bad-loan write-offs, though still modest, are creeping higher. Despite years of steady profits, investors have punished the stock, which even after a recent rebound has lost 27 percent of its value this year.

If U.S. banks absorb big losses on their $2 trillion in commercial real estate loans, the entire economy will suffer. Just the fear of looming bankruptcies and defaults has prompted banks in recent months to restrict new lending, at a time when the virus-ravaged economy needs all the help it can get.

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Tighter credit standards make it harder for commercial borrowers to roll over old loans as they come due and could starve other businesses of capital needed to expand and hire more workers. If the economic downturn proves lengthy, mounting losses could even undermine financial stability, according to some Federal Reserve officials, economists and credit analysts.

“This is something that could make a bad situation worse,” said Adam Slater, lead economist for Oxford Economics in London. “What we don’t want is to get really nasty stresses and strains in the financial system from something like this.”

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Today’s worries are grounded in history. Banks have repeatedly failed after stumbling into big losses on commercial real estate loans, from the savings-and-loan crisis of the 1980s to the Great Recession in 2008. U.S. banks lost $110 billion on commercial real estate in the last financial crisis, at least one-quarter of their total losses, according to Oxford Economics.

This time, the losses could be even worse, with the pandemic forcing a fundamental reconsideration of how Americans work, shop and live. With a highly contagious disease circulating in the country, tens of millions of people have been working for months from home, shopping online and only occasionally visiting shops and eateries.

If a coronavirus vaccine becomes widely available in the first half of 2021, people may revert to their old habits. But some societal changes may endure, especially if a vaccine takes longer to develop or offers only limited protection.

Such shifts would make downtown office buildings, hotels and stores less valuable, sending losses ripping through banks and bond investors that hold $3.4 trillion in commercial real estate debt.

Office space, the largest single slice of the commercial real estate sector, already is seeing rents fall as vacancies rise. Property values eventually could plummet 20 to 35 percent, according to a recent Barclays report. Hotels and retail properties have been hit even harder.

Regulatory changes enacted in the aftermath of the 2008 crisis mean banks now are better armored against losses. But more than a decade of ultra-low interest rates has allowed financial risks to accumulate, which the pandemic is now laying bare.

The Federal Deposit Insurance Corp. (FDIC) regards 356 banks as “concentrated” in commercial real estate, based upon criteria such as the ratio of their CRE loans to their capital base and the pace of loan growth over the past three years.

Valley National Bancorp in Wayne, N.J., is the largest bank to exceed the regulatory guidance. Its CRE loan portfolio has grown by 81 percent in the past three years, according to S&P Global.

“We remain confident in our underwriting and believe we are well positioned to navigate the current environment from a credit perspective,” Michael Hagedorn, the bank’s chief financial officer, told investors last month.

Community banks are particularly dependent on lending for commercial properties. These smaller banks get into trouble with these loans by growing too fast and expanding into geographic areas where they lack expertise, according to Bert Ely, a banking consultant.

Banks that exceed the FDIC criteria were “three to four times” as likely to fail than other institutions during previous downturns, according to a 2019 study by the Federal Reserve Bank of Philadelphia.

“In the event of another such crisis, most banks would be affected, and many might fail,” wrote economist Pablo D’Erasmo, the author. “The CRE sector remains a potential source of instability for the banking sector.”

In the second quarter, banks reported the largest percentage increase in charge-offs for bad loans since early 2010, according to the FDIC. They also nearly quadrupled the reserves they set aside to absorb loan losses.

“I don’t see any way of avoiding a great deal of pain in the commercial real estate market in 2021. It’s almost inevitable,” said Cam Fine, the former president of the Independent Community Bankers of America. “My friends at the Federal Reserve and the FDIC are becoming increasingly uncomfortable with what’s going on in the commercial real estate world.”

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