Lender Life


Is CRE Taking Wing?

By Katie Kuehner-Hebert

After tumbling hard during the Wall Street financial crash, commercial real estate lending appears to be perking up again, particularly in the areas of the country experiencing the greatest job growth.

The most recent CRE lending activity in certain markets has involved both commercial borrowers seeking to tap existing lines of credit, as well as real estate developers renovating existing commercial properties or even building new ones, several commercial lending advisors say. The newest CRE projects have also involved various types of properties, from office buildings and retail storefront sites to residential apartment buildings and even single-family home construction.

According to the FDIC, community banks reported increases in loan balances across all loan categories in 2013 and the first quarter for 2014. Several commercial lending experts project the average total industry loan growth will be about 5 percent this year. For commercial and multifamily mortgage originations, however, loans across the banking industry this year could increase by 7 percent, to $300 billion, from last year, according to the Mortgage Bankers Association. By 2016, such commercial loan originations are likely to rise another 11 percent, to about $333 billion, the MBA forecasts.

Several commercial lending advisors to community banks confirm the rise in CRE lending. In particular, CRE lending appears to be rebounding in regions and metropolitan markets experiencing better-than-average job growth, industry consultants say. Those big-city markets include New York, Houston, Dallas-Fort Worth and San Francisco, as well as some smaller metropolitan markets such as Denver; Austin, Texas; and Nashville, Tenn.

Apartment lending especially is revving up, particularly infill development in urban cores. “All those people who lost their homes need some place to live,” says Jeff Judy, principal of the consulting firm Jeff Judy & Associates in Bloomington, Minn. New construction of single-family housing, he adds, is also picking up in some markets such as Texas, California and Florida, “but not much.”

In the hottest markets, credit demand is also picking up on more traditional CRE lending projects, such as owner-occupied or investor properties, particularly for Class C office buildings, says Craig Poms, executive vice president and chief delivery officer at PrecisionLender, a firm in Cary, N.C., that provides loan and deposit pricing software.

Regardless of any upturn or downturn in CRE lending, or any upturn or downturn in any kind of lending, several lending consultants repeat the need for community banks to adhere to the fundamentals of sound lending. In addition to following underwriting practices to ensure few loans fail, they say, loan pricing practices should ensure that loans will earn sufficient profit as well.

But before starting up their CRE lending engines again, community banks should first and foremost “remember the past” and not rush to put loans on the books that either don’t perform or don’t generate sufficient margins to justify their capital allocation and risk, Judy advises.

“It might be OK to give on price some of the time, but not all the time or it will impact the balance sheet,” Judy advises. “Don’t extend terms to 10 to 15 years—the longer you go out, the more risk you’ve got. Keep maturities as short as your market allows and loan-to-value ratios low.”

Jim Adkins, a managing member of Artisan Advisors LLC in Barrington, Ill., agrees, saying maintaining adequate loan pricing remains a huge risk in today’s highly competitive, extremely low interest-rate environment—and one of the greatest potential challenges for community banks engaged in any lending today.

“Right now banks are going to probably be able to put some good loans on the books, but the problem might not be so much about credit risk as it is about banks possibly stretching rates … that could possibly get them into trouble as rates go up,” Adkins says. “They could be caught in a bigger problem with asset-liability issues by having a lot of fixed-rate loans on the books—they will have margin compression.”

Michelle Lucci, a risk management consultant with Banker’s Toolbox in Austin, points out that a significant amount of recent CRE lending involves borrowers activating unused lines of credit for which the banks have already committed to funding. She estimates that about 80 percent of such CRE lines of credit have been used so far, so many banks still have a built-in potential of new lending in their unused commercial lines of credit.

“For lines of credit to builders, bankers should have tighter controls to make sure their construction project is progressing as planned, and that it warrants additional funds being drawn on the loan.”
—Michelle Lucci, risk management consultant

At national and state banking association conferences across the country, Poms sits on panel sessions with regulators who are advising banks to “stick to the fundamentals of underwriting”—requiring equity in the property, personal guarantees and appropriately pricing for risk, he says.

Poms says community banks should also remember to determine an appropriate risk-adjusted return, not only on a loan’s rate and maturity but also on the type of collateral provided, the loan-to-value ratio against that collateral, as well as a loan’s amortization schedule.

While returning to CRE lending, community banks should still be careful to avoid generating outsized loan balances either to any one borrower or group of borrowers, Adkins says. Many experienced lenders left the business after the real estate downturn, he says, so community banks looking to take advantage of emerging CRE opportunities should also evaluate whether they still have the right “CRE lending talent.”

Charles Wendel, president of Financial Institutions Consulting Inc. in New York City, says community banks should continue to work hard on developing “franchise value,” which includes managing their CRE or other lending in a way that will remain profitable in the long term. “I’m very suspicious of banks relying on CRE lending once again,” Wendel says. “Margins are getting narrowed again as banks go back into these markets, because community banks are notorious for charging too little. I think banks need to make sure that they maintain rigorous pricing and are not stretching for deals.”

Poms sounds a more optimistic tone. “There are still not a lot of deals out there, so everybody is chasing the same deal and all the same way,” he says.

“In today’s highly competitive environment, understanding the risk-adjusted return for your loans helps you decide which deals make sense and which ones don’t.”

Katie Kuehner-Hebert is a writer in California.