Given the heightened credit risks associated with commercial real estate exposure — especially during the pandemic — banks and regulators should provide more comprehensive, comparable disclosure, says DBRS Morningstar.
In a new report, the rating agency examined global bank exposure to commercial real estate (CRE), which is historically more cyclical and volatile than other forms of lending, causing trouble for banks.
“In the past few decades, CRE lending has contributed to a number of bank failures in both the U.S. and in Europe,” the report said. “These bank failures are largely characterized by high risk concentrations in CRE lending as well as weakness in the bank’s underwriting standards…”
With the current economic disruption due to the Covid-19 pandemic and the history of turmoil for banks with significant CRE lending exposure, “we expect banks with high concentrations of CRE to be more vulnerable to the economic fallout than those with more diversified loan portfolios,” the report said.
CRE lending risk varies by factors such as property type, loan-to-value ratios and geography, the report said. But disclosure from banks about these details is generally limited, making the task of assessing those exposures — particularly across different regions — difficult.
“Public disclosures made by banks about their CRE lending typically do not provide enough details regarding composition by property type, banks’ underwriting standards, and the geographic diversification of their CRE loans,” the report said.
For instance, in Canada, disclosure is typically “limited to a bank’s aggregate exposure to commercial real estate, which is usually only available for the largest Canadian banks on a quarterly basis,” the report said, adding that there’s no regulatory requirement for banks and credit unions to disclose their CRE exposure.
This issue has been even more acute during the pandemic, as certain sectors have been more severely affected than others due to localized lockdowns, travel restrictions and public health demands for social distancing.
“The impact from the global pandemic has further intensified the need for increased disclosures globally,” the report said.
To address the issue, DBRS Morningstar called on banks to provide better disclosure about their CRE loan portfolios. Some banks have voluntarily enhanced disclosure since the onset of the pandemic, the rating agency said. “However, not all banks are providing these disclosures and they are not consistent,” the report noted.
The rating agency called for “broader participation from banks globally to provide some additional information in order to enhance the understanding of risks related to a bank’s exposure to CRE.”
The report also suggested that regulators seek to enhance the transparency and comparability of CRE exposures.
“This would include developing a common set of regular disclosures, which are based on a common CRE definition as well as consistent nomenclature,” the report said.