How Much Do Banks Reserve and Charge Off Against Office Loans?
No single reserve or charge-off percentage applies to office loans. One large general office portfolio, about 5% of its lender’s commercial loans, shows 4% already charged off and another 10.2% reserved. The reserve estimates losses still to come, while a charge-off removes value from the books and draws down that reserve, so the two figures answer different questions and run on different clocks.
Why the allowance and the charge-off sit on different lines
The allowance for credit losses is an estimate of losses anticipated in the loan portfolio. A charge-off is the point where loan or lease value is actually removed from the books and charged against that reserve.
Coverage ratios and charge-off rates therefore move on different clocks. A lender that expects heavy losses can carry a large allowance while recording little in charge-offs, because the reserve is built before the loss is recognized.
Collectibility of commercial real estate and every other exposure is analyzed at least quarterly, with an allowance held both for impaired loans and for the remainder of the portfolio.
That second part matters for office. A loan that is current and not impaired still sits in the remainder of the portfolio and still draws a reserve.
“In contrast to the ACL coverage ratio, which reflects anticipated losses, the charge-off rate reflects the percentage of value of loans and leases actually removed from the books and charged against loss reserves.”
How the allowance rolls forward each period
The allowance is a balance, and it moves by a simple identity. Ending allowance equals beginning allowance plus provision, minus charge-offs, plus recoveries.
The provision is the income statement expense and the plug that makes the identity work. Once a charge-off draws the allowance down, enough provision has to be added to bring the balance back to the level the loss estimate requires for the loans that remain.
Two consequences follow. A large charge-off against a reserve that was already adequate needs little new provision, because the loss was anticipated.
A charge-off against a thin reserve forces a large provision in the same period, and earnings absorb it at once.
One office portfolio, read in two layers
A $3.6 billion general office portfolio made up about 5% of one lender’s commercial loans. Of that portfolio, 4% had been charged off and another 10.2% was reserved.
The two layers stack. The first is loss already taken, and the second is loss anticipated on what remains. Adding them requires knowing the base each percentage uses, since a rate on the original balance and a rate on the current balance describe different dollars.
In the judgment of that lender’s management, the loss assumptions behind the reserve are severe enough that conditions would have to worsen substantially to exceed them. That is an opinion about one portfolio and gives no loss estimate for office loans generally.
Size cohorts show how wide the CRE range runs
In one quarter, median commercial real estate charge-off rates were 21.6 basis points for the largest global banks and 1.5 basis points for community banks. Median allowance coverage ratios were 297 and 111 basis points for the same two groups.
Those are portfolio-wide CRE medians by bank size. They blend office with every other property type, so they cannot stand in for an office-only rate.
Problem loans show a similar spread over time. Banks with more than $100 billion in assets carried 207 basis points of problem CRE loans at one year-end, against 107 basis points a year earlier.
Problem classification and the allowance are separate measures, and a rise in one does not fix the size of the other.
Capital concentration tests count the allowance as capital
CRE concentration gets flagged when certain CRE loan ratios to Tier 1 capital plus the allowance for credit losses exceed specified thresholds. Those thresholds are supervisory indicators that prompt closer review, and they are not hard limits.
Because the allowance sits in the denominator, a reserve build lifts the capital measure and lowers the ratio for a given loan balance. The ratio can move through reserving alone, with no loan sold.
Banks with total assets over $1 billion complete Call Report Schedule RI-C, which breaks the allowance into categories and supports peer comparisons of coverage.
Dividing a total CRE allowance by an office-only balance mixes two populations and produces a ratio that describes neither.
Worked example: a $2 billion office portfolio under a base case and a stressed case
The inputs are hypothetical and chosen for round arithmetic. A lender holds $2 billion of office loans with a beginning allowance of 6 percent. Recoveries are zero and no loans pay off during the period. After the period, the allowance is reset to a stated percent of the remaining balance.
Beginning allowance: $2 billion multiplied by 0.06 equals $120 million.
Flat coverage after heavy charge-offs does not show how much provision was booked. Provision depends on recoveries and on the change in the loan balance as well. In the example, holding 6 percent coverage after $20 million of charge-offs would take $18.8 million of provision, slightly less than the charge-offs.
Base case: charge-offs are $20 million, a charge-off rate of 1 percent ($20 million divided by $2 billion, multiplied by 100). The remaining balance is $2 billion minus $20 million, or $1.98 billion. The required allowance is 8 percent of that balance, $158.4 million. After the charge-off draws the reserve down, the balance is $120 million minus $20 million, or $100 million. The provision needed to reach $158.4 million is $158.4 million minus $100 million, or $58.4 million.
Stressed case: charge-offs are $60 million, a rate of 3 percent. The remaining balance is $1.94 billion. The required allowance is 10 percent of that balance, $194 million. After the charge-off the reserve stands at $120 million minus $60 million, or $60 million. The provision is $194 million minus $60 million, or $134 million.
On the same starting portfolio, the stressed case needs $75.6 million more provision than the base case ($134 million minus $58.4 million). Ending coverage is 10 percent against 8 percent, and charge-offs are three times larger.
Coverage read without the charge-off line understates how much the period cost.
Mistakes in reading office loss figures
Treating coverage as realized loss confuses an estimate with a removal. The coverage ratio reflects anticipated losses, and the charge-off rate reflects value actually taken off the books. A large allowance can be fully consumed, partly consumed or never touched, depending on what the loans do.
Adding a charge-off percentage to an allowance percentage without checking denominators misstates exposure. If one rate uses the original balance and the other uses the balance after charge-offs, the sum covers two different dollar bases. In the worked example the base shrank from $2 billion to $1.98 billion, so the two percentages apply to different amounts.
Calling a CRE cohort median an office statistic changes the population. A median across all CRE types describes the typical bank in that group, and a particular office portfolio can sit well above or below it.
Reading a period charge-off rate as a cycle estimate stretches one slice of time over an entire loss cycle. Charge-offs recognized in one quarter reflect resolutions that happened in that quarter, and losses already reserved can still be waiting.
Ignoring the provision identity hides where earnings absorbed the cost.
Checklist questions for an office allowance review
Is the figure an allowance or a charge-off? The first is an estimate of anticipated loss, and the second is value already removed from the books.
Does the percentage sit on the original balance or the remaining balance? The base decides which dollars the rate describes.
Is the rate office-specific or CRE-wide? Cohort medians cover every property type in the portfolio.
What period does the charge-off rate cover? A single quarter says little about a full cycle of resolutions.
How much provision was booked alongside the charge-offs? Provision connects the allowance balance to earnings.
Does the allowance sit in a concentration ratio the lender is tracked on? Reserves enter the capital measure in the denominator, so a build changes the ratio.
Does the Schedule RI-C detail separate the category being compared? Banks over the asset threshold report the allowance by category, and smaller banks may not.
Are problem loans rising alongside the allowance? Problem classification and the reserve are separate measures, and the gap between them shows how much of the stress has been provided for.