U.S. bankers haven't taken their foot off the gas yet but they are watching their CRE loan portfolios carefully following a recent warning from the FDIC and say they are prepared to hit the brakes and slow down their commercial real estate
lending vehicles should conditions warrant.
Through the third quarter of 2015, U.S. banks had steadily increased their total CRE loans outstanding to $1.8 trillion -- exceeding the previous lending peak at the end of the second quarter of 2007 by some $170 billion.
CRE loan underwriting standards have also eased over the past three consecutive years, according to U.S. banking statistics. So much so, in fact, that the FDIC last month issued a stark warning to banks, directing them to "reinforce prudent risk-management practices" for their commercial real estate lending.
The FDIC regulators also added that they would be paying close attention to bank CRE lending practices in their 2016 bank reviews. The last time the FDIC sent such a memo regarding real estate lending was in 2005.
"We actually think the regulators are right,” Chris Gorman, president of KeyCorp’s Corporate Bank, told analysts this past week. "We think the market is a little hot in certain areas."
Gorman told analysts to expect slower CRE lending growth from KeyCorp. The bank holding company said it would also be adjusting its outlook for housing and that analysts could see a lot less construction loan activity from KeyCorp compared to its peers.
KeyCorp’s position does not appear to represent the consensus opinion, however. CRE market fundamentals and pricing are still strong and bankers in general said they are reluctant to leave while the party is still going strong.
“As it relates to the question on the health of the commercial real estate market, we see lease-ups happening as modeled or better than modeled. We continue to see the permanent market taking those kind of loans out earlier than we’ve ever experienced,” Claude Davis, CEO of First Financial Bancorp, told analysts. “So at least to this point, we’ve seen a pretty strong and healthy market.”
Obviously, Davis added, there are some markets that are soft, but First Financial continues to like multifamily, health care and build-to-suit office.
“It's a little early to be able to say where we want to be stepping on the brakes and where we want to be stepping on the gas yet,” John Kanas, chairman, president and CEO of BankUnited told analysts. “We will watch commercial real estate very carefully... and act accordingly as we see that business ebb and flow. But there is no intention here of eliminating one market and emphasizing another in its entirety.”
What the federal banking regulators warning doesn’t take into account, Kanas said, is the differentiation in CRE property types and markets.
“The regulators have one category: commercial real estate. That [could mean] a construction loan out in the desert someplace of a hotel and also a 60% loan to value fully cash flowing apartment building on Madison Avenue in Manhattan,” he said. “So clearly the regulators are looking at the more speculative areas of commercial real estate and getting nervous about it.”
The trick is to manage where you lend, what property type you lend on, and the underwriting of the loans. And in that regard, bankers generally agreed they were going to be a lot more selective in 2016.
“Appraised values have gone up quite a bit,” said Richard Thomas, executive vice president and CFO of CVB Financial, “So you have to make sure you keep the integrity of your debt service coverage intact, so that as these cap rates get lower and lower on real estate properties, you're not over lending against the cash flow.”
“We also look at, when we underwrite a property today, we look at what was this property worth in 2009 and 2010, and how much are we really lending relative to that value,” Thomas said. “That's our downside test.”