Amid Caution, Bank Lending Remains Robust

Despite regulatory warnings about banks' rising exposure to commercial real estate, lending volume has showed little signs of slowing down in 2016.
Jamie Woodwell

Jamie Woodwell, Vice President for Commercial and Multifamily Research, Mortgage Bankers Association

Banks were the most prolific commercial real estate mortgage lenders last year, and they appear to be heading toward another first-place finish in 2016. Originations totaled $138.6 billion, about 28 percent of all mortgage lending and well ahead of the $99.4 billion in CMBS issuance, according to Mortgage Bankers Association data. MBA projects that mortgage lending from all sources will increase 3 percent to a record $511 billion this year. Even though federal regulators cautioned banks about their rising exposure to commercial real estate, so far lending volume has displayed little or no fallout.

“What we are seeing so far in 2016 from commercial banks is a continuation of what we saw in 2015,” explained Jamie Woodwell, the MBA’s vice president for commercial and multifamily research. To Woodwell’s point, commercial banks posted a 44 percent year-over-year gain in commercial real estate lending during the first quarter, according to the MBA’s Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations.

By contrast, insurance company lending was down 1 percent year-over-year during the first quarter, CMBS and conduit volume slipped 19 percent, and lending by Fannie Mae and Freddie Mac fell 22 percent.

That year-over-year figure may prove to be a more reliable signal than the 39 percent decline in bank lending volume recorded from the fourth quarter of 2015 to the first quarter of this year. That trend was in line with those of CMBS lenders (down 29 percent), life companies (32 percent) and Fannie Mae/Freddie Mac (45 percent).

“Commercial banks have had a strong appetite for commercial and multifamily mortgages and added to their balance sheets a large number of these mortgages. And the early data for 2016 shows that continuing,” Woodwell explained.

Rolling the Dice?

Joseph Orefice, Head of CRE Lending, Investors Bank

Joseph Orefice, Head of CRE Lending, Investors Bank

Hanging over the bank lending climate is last year’s much-discussed joint statement from the Federal Reserve Bank, the Federal Deposit Insurance Corp. (FDIC) and the Office of the Comptroller of the Currency (OCC). The regulators expressed concern about relaxed underwriting and the increasing size of banks’ real estate loan portfolios. By last September, development loan lending was rising at a 15 percent annual rate, much faster than other bank lending categories.

“Every year that we move away from 2008 to 2009 gets us a year deeper and deeper into the real estate recovery,” noted Gregg Gerken, head of U.S commercial real estate lending at TD Bank. “At some point, we will see the turn in the cycle. And you usually don’t know when that happens until you are looking in your rearview mirror. So I think the Fed was just concerned that banks shouldn’t get too far out over their skis.”

The regulators also pointed to banks’ rising exposure to multifamily properties, and rising competition for these properties. Joseph Orefice, head of commercial real estate lending for Short Hills, N.J.-based Investors Bank, noted, “The trend has been that there is more thought going into some of the higher-end new units that are coming online, and how that supply will be absorbed, and how many projects are underway. We are like everybody else. We will wait and see how that goes. But it’s not a question of a bubble bursting as much as it is a kind of pause in the growth, if it even occurs at all.”

Banks are also bracing for the new Basel III standards that call for higher capital on certain acquisition, development and construction loans, referred to as high-volatility commercial real estate loans (HVCRE).

Favorable Signs

Despite these issues, Gerken is seeing an uptick in development. Office and industrial development are picking up steadily, whereas previously the multifamily sector had accounted for much of the new development activity. Retail development has been more subdued, as owners focus on repositioning and redevelopment rather than ground-up projects.

The improving economy also bodes well for refinancing commercial mortgages that were originated in 2006 and 2007, at the peak of the last cycle. Woodwell noted, “If one looks at the macro environment and where we are now, versus where we were when the loans were made, interest rates are lower, property incomes and property values have generally increased, so that’s all a net positive.”

Investors Bank recently originated a $35 million permanent mortgage on a 240-unit multifamily community in Bound Brook, N.J.

Investors Bank recently originated a $35 million permanent mortgage on a 240-unit multifamily community in Bound Brook, N.J.

Still, refinancing some bank loans will pose a challenge. One factor may be lower-than-expected CMBS volume. Since the beginning of the year, early projections for $115 billion to $130 billion have been revised down to $100 billion to $110 billion. This would seem to provide an opening for banks, but in light of stepped-up scrutiny by regulators and rising cost of capital, banks will probably take a cautious approach to refinancing opportunities.

Those who opt for an adjustable-rate mortgage today are also hopeful about their refinancing prospects. “A lot of these guys are actively managing and developing and trying to buy the opportunity to get more proceeds, or do something else, or sell after five years,” Orefice pointed out. Investors Bank recently originated a $35 million permanent mortgage on a 240-unit multifamily property in Bound Brook, N.J. The 3.625 percent interest rate will adjust after the loan’s seventh year.

And with cap rates at historic lows, it seems the only way they can move is up, especially with the Federal Reserve expected to continue hiking up rates this year. “At some point, the cost of at least the debt side of the cap rate equation will begin to go up,” Gerken noted. “And therefore, you will start to see cap rates expanding a little bit. Banks having lent a little lower on loan-to-value, using debt yield gives a bit more margin of safety in absorbing any potential increase in cap rates.”

In practice, that translates to relatively conservative LTVs. For TD Bank, the range is 60 to 70 percent, and the bank looks to a debt yield in the 8.5 to 10 percent range. Similarly, Investors Bank is willing to offer an LTV of as much as 70 percent on commercial properties and 75 percent on multifamily.