It's no secret that certain commercial real estate loans have become a lot riskier since the coronavirus pandemic emerged earlier this year. After all, the desire to prevent the spread of the virus has made traveling and staying in hotels, going to shopping malls, working in the office, and even regularly eating in restaurants a lot less attractive. Seeing the apparent risk, banks have been setting aside lots of cash to cover potential losses on loans to industries vulnerable to the pandemic.
While many appear to be thinking about it conservatively, and deferrals have come down significantly in the last few months, there is still lots of uncertainty regarding the credit risks of borrowers. If coronavirus cases rise to a level that pushes states into new stay-at-home orders, or if the pandemic permanently changes consumer behavior, these loan segments could be facing more trouble.
One of the main ways a bank can get into trouble is when loans default. So, investors should examine the total exposure of banks to these vulnerable industries, as well as look at how much banks are currently setting aside to cover losses.
Image source: Wells Fargo.
Exposure
In my analysis, I am only looking at the commercial real estate (CRE) portfolios, which are loans used to purchase or develop a property, although sometimes banks break out the commercial construction loans into their own folder.
CRE does not include all potential commercial exposure to vulnerable sectors. For instance, banks also provide working capital or finance equipment purchases to businesses through commercial and industrial loans. However, CRE loans are typically larger, and if the demand to go to offices, retail businesses, and hotels falls, the value of some of the buildings behind these loans could deteriorate, hurting the borrower and the lender.
| Bank |
Total CRE Portfolio (billions) |
Office (billions) |
Retail (billions) |
Hotel/Lodging (billions) |
|---|---|---|---|---|
| JPMorgan Chase (JPM 1.65%) | $148.7 | $16.7 | $11.3 | $3.5 |
| Bank of America (BAC 3.45%) | $64.1 | $17.8 | $8.4 | $7.5 |
| Wells Fargo (WFC 3.19%) | $147.7 | $38.5 | $14.4 | $12.2 |
| Citigroup (C 1.68%) | $58.9 | NA | NA | NA |
| U.S. Bancorp (USB 1.48%) | $41.1 | NA | NA | NA |
| PNC (PNC 3.09%) | $28.8 | $7.8 | $3.6 | $1.9 |
Source: Bank Financial Statements. NA = not available.
Of this group, Wells Fargo has the most exposure to hotels, retail, and office loans. This is total outstanding loan volumes in these sectors, and not troublesome loans. Wells Fargo's $38.5 billion in office loans represents 4% of its total loan book. JPMorgan has an equally large CRE loan book as Wells Fargo, but much smaller exposure in some of these areas, especially office and hotels. Meanwhile, Bank of America has a much smaller commercial real estate book, but more office and hotel loans in terms of volume than JPMorgan.
Some of the data was harder to decipher. I couldn't find a breakdown of Citigroup's CRE exposure, but in general it has a smaller loan book than Wells Fargo, JPMorgan, and Bank of America. U.S. Bancorp provided the company's commercial lending exposure, but did it as a percentage of total loans, making it difficult to know which ones are tied to CRE. Overall, though, U.S. Bancorp said retail and restaurants made up 4.6% of total loans, while lodging is 1.4% of total loans .
PNC provided some good insight because while its CRE book is much smaller than its larger peers, the exposure to some of these sectors is significant when you look at the proportions. For instance, office loans make up roughly 27% of the bank's CRE portfolio, which is more than Wells Fargo even though Wells Fargo has the largest total outstanding balance.
Reserves
While banks have not listed the specific reserves being set aside for office, retail, and hotel loans, we can see how much they set aside to cover losses in their CRE folders.
Banks ultimately only expect a portion of these folders to be at risk of default. At the end of June 30, Wells Fargo had granted deferrals on 11% of its CRE loan book , and since then CFO John Shrewsberry has said deferrals have come down significantly in recent months . The bank at that time had also aside $2.4 billion, the equivalent of roughly 1.6% of its commercial real estate book, to cover potential loan losses .
Bank of America had set aside about $2.2 billion for potential CRE loses as of June 30, amounting to roughly 3.5% of its total CRE loans . JPMorgan Chase had set aside about $11.4 billion to cover potential losses as in its wholesale book, but its wholesale book includes many segments in addition to CRE. .
Of course, it only takes a small number of defaults to get a bank into trouble. According to a recent report by Deloitte, charge-offs (debt deemed unlikely to be collected) in a loan segment referred to as "other property loans," which includes those secured by office, retail, industrial, and hotel properties, reached 1.65% at the peak of the Great Recession in 2010. The consulting firm only expects charge-offs in this same category to hit 0.47% in 2021. If that ends up being true, then these large banks are likely pretty well reserved for now .
Uncertainty persists
Ultimately, it appears most of the big banks are at least thinking somewhat conservatively about their most vulnerable loans. But we don't know the exact reserve levels for these segments, and we also don't know how bad coronavirus cases could get during the winter or how consumer behavior might change before the pandemic subsides. That's why it's important to keep overall exposure in risky categories in the back of your head in case these sectors are more negatively affected in the future.
