Reserves cushioned banks from 2d-quarter market.

Heavy loan-loss reserves required by regulators cushioned banks from a further deterioration in commercial real estate markets in the second quarter..

Bank of Boston Corp., First Interstate Bancorp, First Chicago Corp., Midlantic Corp., and Barnett Banks Inc. scored quarterly earnings gains attributable to improvements in real estate portfolios. The pace of deterioration slowed at other major banks, including Citicorp, the biggest commercial real estate lender.

The earnings results, also bolstered by low interest rates, are good news to regulators, who have drawn heat for exacerbating the credit crunch by forcing heaving reserving against real estate.

Early Warning

"It's only in hindsight, but the effect [of tough supervision] has been to recognize the problems more quickly and get the problems behind [the banks] more quickly," said Ronald I. Mandle, a bank analyst at Sanford C. Bernstein & Co.

"From the developers' point of view it still may be getting worse, but from the banks' point of view the situation has stabilized."

In a report issued last week, Salomon Brothers Inc. said that gains in economic growth early in the year evaporated in the second quarter, dashing hopes that leasing of unused space will pick up. Downtown office rental rates have sunk to a 20-year low of under $17 per square foot, the report said.

Separately, the accounting firm Coopers & Lybrand noted 62 square feet of vacant space for every office worker in the nation - nearly four times the normal amount - and said it could take up to 12 years for that sector of the market to recover fully.

But banks, with more than $300 billion of commercial real estate loans, seemed immune to the trend, at least for one quarter.

Rebound for Bank of Boston

Bank of Boston scored what may have been the most convincing comeback from real estate problems.

It earned $62.4 million in the quarter, compared to a $49.5 million loss in the 1991 period. Bad assets fell 13.1% to $207 million. In addition, the bank built reserves to 142% of problem loans, while reducing chargeoffs to $42.2 million from $75 million.

Los Angeles-based First Interstate earned $64.5 million in the quarter, after losing $80.3 million in the period last year. Although nonperforming loans rose slightly, at 3.5% of all loans, First Interstate's loss provisions of $87.8 million and chargeoffs of $77.2 million compared with a $295 million provision and chargeoff of $173.6 million last year.

Moderate Improvements

Another back hit by real estate woes, Midlantic Corp., Edison, N.J., reported its first quarterly profit in two years, earning $7.8 million. It reduced nonperforming assets by 7.7% to $1.62 billion.

Loss provisions and chargeoffs rose at First Chicago, but the bank reduced nonperformers to 3.3% of loans from 3.7%. And Barnett Banks Inc., Jacksonville, Fla., cut its provision nearly in half from the level in the second quarter of 1991, to $48.1 million.

At citicorp, losses on North American real estate were $355 million, higher than a $108 million loss in the 1991 quarter but an improvement over the $463 million loss in the first quarter.

Salomon's real estate analysts headed by S. Michael Giliberto and David Shulman, say the overall real estate environment is worsening.

"Retail sales growth has retreated from its first-quarter high," the Salomon analysts wrote in their quarterly report on the real estate market. "Employment losses that had begun to moderate in some sectors have risen again. And vacancy rates have increased in the industrial and downtown office markets."

Real estate investors continued to take "modest writedowns" that the Salomon compared to "death . . . by slow cuts."

Commitments Lagging

Commercial mortgage loan commitments remained low, though the $4.65 billion volume was the highest since yearend 1990, the report said.

And loan delinquencies continued to rise - to 4.1% for retail space, 8.1% for offices, and 3.9% for industrial properties.

The Coopers study put the statistics in stark terms, noting that the equivalent of 3,800 shopping centers sit empty and one million hotels rooms, or 42 rooms in each hotel, remain unused each night.

"Current absorption rates suggest the market nationwide will face a widespread oversupply of product for years to come," said Bjorn Hanson, national real estate chairman of the accounting firm.

But the picture is not entirely grim. "What we're starting to see are cash-flow improvements," Mr. Hansen said.

Not Out of the Woods

There still may be some isolated surprises in store for banks, because of leases rolling over while rental rates are low. And fire sales may create stiff pricing competition for buildings that are current on their loans today. But basically, he said, "banks know what their problems are."

John D. Leonard, the banking analyst at Salomon Brothers, said declines in interest rates were a plus for lenders with problem real estate.

"The carrying costs of property are lower. And buildings financed on a floating-rate basis have lowered debt costs" which keeps more loans on a performing basis, he said.

"The other factor is that banks have had pretty aggressive workout teams in place for 12 to 18 months," Mr. Leonard said.

Assuming the Worst

Mr. Mandle of Sanford Bernstein said examiners, hardened by the long economic downturn in Texas, took a new approach when similar problems cropped up in New England and the Southeast. "They made their cash-flow assumptions based on deteriorating conditions," he said.

That forced banks to write down loans that were performing based on current income from the properties. "Within three to six months, many of those loans did become nonperforming, but the banks had already reserved for the losses," Mr. Mandle said.

To be sure, an uptick in interest rates could cancel some of the bank's recent gains.

"We would see pressure both on the margin line and the credit quality," Mr. Leonard said.

And Mr. Mandle suggested another dip in the economy could force banks to recognize a new round of losses.

But every new earnings report seems to provide fresh evidence that banks are bouncing back ahead of the rest of the economy.

"It's hard to call what we're seeing a recovery, but we've seen the worst," said Mr. Hansen.

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