"We're seeing more competition in deals now than we did six months ago or a year ago," Dave Seleski, CEO of Stonegate Bank in Fort Lauderdale, FL, says. "Every bank is more cognizant of their portfolio mix and some are cautiously increasing their appetite for certain assets," he says.

In fact, the interest of these banks for, say, multifamily versus office assets is very telling in itself. "During the recession," says Seleski, "most banks viewed commercial real estate as one category and not a very favorable one at that. Now that valuations are returning, more banks are starting to distinguish among the asset classes, developing preferences or specializations in certain categories." Stonegate, for example, just financed two multifamily assets in Tampa for $14 million. "It's granular now. Some banks will not consider just office but only owner occupied office."

Indeed, examples of even small banks lending to local commercial real estate projects can be found in most markets now. Washington Trust, Rhode Island's largest independent bank, provided a $2-million loan to Coastal Holdings Warwick LLC for the refinance of a 121-key Motel 6 in Warwick. It also provided $6.9 million to CT Properties to refi Colony Shopping Plaza on North Colony Road in Wallingford, CT. The 97,202-square-foot shopping center is anchored by Staples and Dollar Tree. In Chicago, BB&T Real Estate Funding increased its portfolio capacity from $400 million to $800 million this spring, allowing the firm to expand its lending capabilities through Grandbridge Real Estate Capital. Northeast Community Bank announced it was expanding its commercial real lending operations in Massachusetts.

There are many reasons for this thaw. One, as FDIC and Trepp have noted, bank balance sheets and profit margins have been steadily improving. Also, banks are in the business of making money after all, and there are few investments available that deliver a decent yield.

Hotels are an example of an asset class that attracts bank lending for this reason, says Guy Maisnik, a Los Angeles-based partner with Jeffer Mangels Butler & Mitchell. "We've seen hotel fundamentals improve," he says. "They've proven more nimble than other assets, which banks like. Hotels have to face changes in economic fundamentals immediately, as they happen, and have learned to adapt pricing and marketing strategies accordingly." There is also evidence that demand for commercial real estate finance on the part of developers and real estate partnerships- a missing component in 2009 and 2010-is growing as well.

Around the same time that the FDIC released its fateful report, the Federal Reserve Bank's monthly Senior Loan Officer Opinion Survey on Bank Lending Practices came out. It found that more than one-third of large domestic banks described demand for commercial real estate loans as having strengthened over the previous three months. Smaller banks indicated that demand for such loans had remained about unchanged, while some 15% of foreign banks noted an increase in demand.

Unfortunately, increased appetite by banks plus growing demand for lending products does not equal more supply. The simple and overriding reason: Regulators continue to lean heavily on local banks, overseeing their books with a still-skeptical eye.

Bank regulation falls into three areas depending on the institutions' legal status. The Federal Reserve oversees state-chartered member banks of the Federal Reserve System. The FDIC oversees state nonmember banks and savings institutions and the US Office of the Comptroller of the Currency's purview is federally chartered national banks.

For the most part, according to a recent report by the Government Accountability Office, these regulators tend to view community banks as overexposed to commercial real estate (see chart 1). The report cited FDIC figures that found that nearly 30% of community banks have concentrations of commercial real estate to total capital above 300%, the concentration threshold established in the 2006 interagency guidance on commercial real estate. This means that in regulators' eyes, nearly a third of community banks are exposing three times their total capital to risks related to their CRE loans.

Recent loan history is another factor by which regulators rate a bank's books and in the case of commercial real estate, recent history has not been kind, says Wayne Rogers of Wayne Rogers & Co. in Los Angeles. If the recent loan experience has been, say a 5% default rate, then any new loan must reserve for that amount, he explains, in addition to the 8% that is currently mandated for reserves. If the new loan is $10 million, $1.3 million must go into reserves and not earn the interest rate charged for the loan, which in turn means that it is not profitable to make the loan. "If a new appraisal is less than the original, the difference in that amount must be charged against capital never to be recovered," Rogers says. "So why make the loan?"

The overall history of the industry does not help either. GAO also found that many bank failures are associated with high commercial real estate concentrations (see chart 2). Despite this weight of statistical evidence, banks say that regulators are applying rules more stringently than necessary-and certainly more so than they did before the recession.

For example, examiners have been more critical of recent appraisals, banks say, requiring valuations on commercial real estate collateral more often and becoming more critical of the banks' appraisal review process. There are also disagreements on how CRE concentrations should be calculated. Some examiners include owner-occupied real estate when they shouldn't, GAO says. Others may use the wrong type of capital for the calculation, which inflates the concentration levels. The end result has been more than a few banks that were told by examiners that they exceeded their thresholds for commercial real estate based on faulty calculations.

The Fed's survey on lending practices also lends additional insight into what is happening. It found that over the past three months, banks continued to ease lending standards and most terms on all major types of loans, unless those loans were secured by real estate. Roughly 75% of domestic respondents indicated that their bank's standards for construction and land development loans were tighter than previous years. By contrast, nearly 25% of foreign respondents reported that their commercial real estate lending standards had eased, on net, over the past three months.

A combination of this regulatory heavy hand and recent economic and market events could easily dampen the re-emergence of commercial banking real estate loans. "The volatility of the past 45 to 60 days will cause many banks to return to the sidelines," predicts Adam Weissburg, a Los Angeles based partner with Cox Castle & Nicholson. "Ultimately, lenders will be willing to take on new risk only when they know that real estate and employment have stabilized."

It will not necessarily take "improvement" in these factors, he says (a relief since economic fundamentals are not likely to improve any time soon-and are likely to deteriorate). Rather, Weissburg believes "it will be the ability to appropriately underwrite without fear of future deterioration of asset value or credit worthiness." This criterion, though, is not likely to be attained by community banks either, unfortunately. Underwriting with an eye to what future valuations of properties might be has become as much art as science in this market, with every player from small banks to large Wall Street investment firms still feeling their way.

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