WSJ recently posed the following math problem:
If an office building in Springfield has lost 60% of its value over the past 3 years, and it has a dry cleaner named Dylan’s (after the owner’s nephew) on the ground floor, and the third-floor co-working space has an industrial-size espresso machine that has never been used, and this year is a leap year, when does it show up in CECL?
“That is an excellent question!” as they say when they don’t know the answer.
The Current Expected Credit Loss (CECL) accounting rules, were implemented from 2020, and were supposed to remedy the backwardness of the previous ruleset, where credit losses didn’t show up on the books until they were probable, i.e. certain to happen (and when can anyone really be certain of anything?)
With CECL the bar was lowered, and losses were supposed to be booked when they were expected, so that everyone, and especially the credit providers themselves, could see what was coming down the pike, or Main Street as it were.
WSJ’s point is that with higher rates and office space sitting as empty as my nest, surely something must pop up.
Commercial real estate is often financed with interest-only loans that roll into the next at maturity, but that practice is predicated on low rates and property values being ever-increasing or at least staying steady, something that can hardly be said for those cubicles currently collecting dust bunnies.
In July, PIMCO warned that about $1.5 TN of CRE loans are about to mature in the next two years. And two years is well within the CECL forecast period.
“It’s a sizable problem”, Jerome Powell said about banks’ office loans on 60 Minutes back in February. “There will be expected losses.”
So, something is about to go down. Or up. Or sideways. Or pear-shaped.
Unless—as WSJ implies—the lenders’ interpretation of “expected” (new accounting rules) is not that different from “probable” (old accounting rules) in which case credit losses will continue to cause surprise, volatility, and systemic risk.
Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.