Mind The Small Bank Sector----They Are Plunging Into Commercial Real Estate


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Local and regional banks, chasing higher-yielding investments, have ramped up lending to commercial real estate developers. While they're filling the gap left by a decline in commercial mortgage-backed securities offerings -- until recently the main funding source for commercial real estate -- the opportunity is also risky for the smaller players.

In the first half of 2016, 41 percent of real estate financing in the U.S. came from national and regional banks, up from 25 percent two years earlier, according to data released last week by real estate data firm Real Capital Analytics.  Conversely, the CMBS market saw its share of commercial real estate funding decrease from 30 percent to 10 percent in that same period.

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The recent plunge in CMBS offerings was due to market volatility, pricing pressures, and new financial regulations that go into effect this December. The new regulations require issuers to retain a larger portion of the CMBSs that they issue -- 5 percent -- which has caused some of the traditional issuers to depart the field altogether.
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All of this has squeezed some commercial borrowers because they want to refinance CMBSs issued in the pre-crisis days of 2006 and 2007 that are now coming due. So they've turned to the smaller banks for help.

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Regional banks have always specialized in local real estate lending, and they can bring a more intimate understanding of local markets to the mix. For example, banks in the Northeast are lending to apartment projects, as rising rents and steady demand for housing in the region make the segment attractive. Regional bank lending in the Midwest is almost evenly split among retail, office and apartment properties.

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So far, there’s little evidence that regional banks’ commercial real estate loans are distressed -- and, in fact, they've been a source of strong profitability at the banks. The level of U.S. bank charge-offs is at a pre-recession low of 0.01 percent, according to Federal Reserve data. That rate was nearly 3 percent in 2009.

A buoyant U.S. commercial real estate market has kept those portfolios healthy, but the worry is what might happen should the market turn.

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This increased exposure at regional and local banks hasn’t gone unnoticed. The Federal Reserve and other regulators havewarned that banks’ exposure to commercial real estate may be too high and their underwriting standards too liberal.

Specifically, regulators are worried about banks with commercial real estate loan exposure that represents more than 300 percent of their total regulatory capital. Suffolk Bancorp, First Internet Bancorp and RBB Bancorp are among those that have recently seen their CRE portfolios as a share of capital rise above that threshold, according to a Morgan Stanley report from July. That report offered a list of banks in the $1-$10 billion asset range that also had major growth in commercial real estate exposure.

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Remember: Lax lending standards caused massive problems not so long ago. High exposure to commercial real estate caused many community banks to fail during the Great Recession, according to a June report by the credit ratings giant, Moody’s Investors Service. Local and regional banks are traditionally more susceptible than national banks to downturns in commercial real estate because they have a smaller asset base, according to data from the Federal Deposit Insurance Corporation.

At this late stage in the credit cycle, Moody’s analyst Tad Philipp advises prudence. “When prices go down, that’s what separates the pack of lenders who’ve been making good loans from those who haven’t.”

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Rani Molla in New York at [email protected]

To contact the editor responsible for this story:
Timothy L. O'Brien at [email protected]

Source: Small Banks Are the New Property Titans

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