Are You Reserving Enough for Commercial Real Estate & Default Risk?

By: Bill Dolan, CMB, AMP

It goes without saying that the pandemic made traveling, staying in hotels and eating out for the most part, far less attractive in 2020 as well as at the start of 2021, thus making these industries incredibly susceptible to default.

Financial institutions have been setting aside significant amounts of cash to their loan-loss reserve accounts (normally taken into income) to cover potential losses that could occur within their commercial real estate portfolios.

Banks not only lend on commercial real estate to purchase and/or develop properties (sometimes they segregate their commercial construction loans into their own folder) but they will also provide the necessary working capital or finance equipment purchases to businesses providing them with commercial and industrial loans. Therefore, if demand to return to work offices, retail businesses, and hotels fall, the values behind some of those properties could significantly decline thus harming both borrower and lender alike.

As Deloitte pointed out in a recent report, charge-offs (debt deemed unlikely to be collected) could get some banks into trouble even on a small number of defaults and therefore, banks are taking a very conservative approach to their most vulnerable loans. The length of time that companies remain closed and the workforce remains unemployed, will determine just how much banks will need to elevate their loan-loss reserves.

The real question is just how long will it take Americans to get vaccinated in order to re-establish the entertainment, travel and hospitality industries, for that is where the uncertainty and timing of it all exists.

If you are in need of Commercial Workout Specialists, please feel free to contact Bill Dolan at (617) 694-2617 to arrange a free consultation.