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Banks might must face heavy losses when industrial property costs fall

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(Photo: Getty Images | d3sign)

SINGAPORE – Commercial property prices have fallen this year as people stopped going to offices and retail stores were disrupted. According to a recent report, this could lead to significant losses for banks.

In previous downturns, commercial home loan losses have been "high" and there are worrying signs that such a trend could repeat itself this time around during the coronavirus-induced slowdown, Oxford Economics' Adam Slater said in a report.

In the worst case scenario, Slater said these credit losses would "significantly undermine" bank capital.

"Large declines in prices (commercial real estate) generally result in huge losses for banks. Write-downs on (commercial real estate) loans have been a major contributor to overall bank losses in the last two major downturns," wrote Slater, an economist at the festivities.

For example, during the great 2008 financial crisis, such loan losses accounted for between 25% and 30% of total loan write-offs in the US.

This time around, those risks are highest in the US, Australia, and parts of Asia like Hong Kong and South Korea. In these economies, credit growth was high and credit risk was "significant". However, commercial property prices are already falling, particularly in Hong Kong, the report said.

In Singapore, office rents had their sharpest drop in eleven years in the third quarter, official data showed on Friday. Office rents fell 4.5% in the last quarter to September.

The company's index of global commercial property prices based on seven major markets shows they are down 6% year over year.

"Could the coronavirus crisis via the commercial real estate sector create long-term problems for the banking and financial system? … we think this is a real problem," wrote Slater.

"Right now, hotel occupancy rates are very low, footfall in retail stores has dropped sharply, and many offices are closed or have very little staff," he said. "In these circumstances, rental income and debt repayments from affected sectors are in serious doubt."

Oxford Economics analyzed 13 major economies and found that 5% write-offs on loans would equate to a loss of between 1% and 10% of the core capital of banks whose main source of finance is equity and income. The greatest effects are felt in Asia.

Bond investors can also be at risk.

In the US, around half of the sector's credit is not provided through bank loans, and this includes the issuance of bonds in this sector, according to the report. In parts of Europe and Asia, this share of non-banking borrowing has risen to 25% or more in recent years.

"In the case of real estate funds, downturns in (commercial real estate) could result in investors paying back their holdings quickly, leading to a fire sale of assets – resulting in price falls and greater credit losses," Slater said.

But there is a bright spot. Banks are better able to accommodate them compared to a decade ago. Their capital and debt ratios are about twice what they were a decade ago, Slater said.

In the wake of the financial crisis, reforms were introduced to mitigate risk and improve the resilience of the global banking sector by maintaining certain leverage ratios and reserves.

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Katherine Clark