What Regulatory Warning? Banks Continue CRE Lending in Q1

The Federal Reserve Bank in Washington DC

WASHINGTON, DC—Banks were duly given notice last December by a troika of regulators: the Federal Reserve’s Board of Governors, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency. They said they would keep a close eye on commercial real estate lending in 2016 as they were concerned about the loosening underwriting standards of these loans. Several weeks later, as banks report their earnings for the first quarter of 2016, it is hard to see what impact the warning had on CRE lending. Banks not only continued to lend in the sector, but reading through the earnings reports and investor calls, one gets the sense that banks would have lent even more if the market weren’t so competitive. Still Very Competitive Yes, even with a CMBS market all but out of commission for the much of the first quarter and a stretch of several weeks during which transaction pricing became quite opaque, the money still flowed to the top deals. Glenn MacInnes, CFO of Webster Financial Corp., in Waterbury, CT, addressed that issue very frankly, in the bank’s earnings call for the quarter. The bank is still finding that for the high-quality apartment, multi-family deals, there still is some significant competition from the regional banks and the big banks, he said. “So we didn’t see price stabilization in CRE in the quarter, but we still find it very, very competitive…” he said. “We actually probably lost more term sheets issued than we had in the prior couple of quarters because of aggressive pricing and aggressive structure and proceeds.” All About the Loans These loan flows are not necessarily a sign that the bank in question is enjoying robust health – although this is also not meant to suggest that the bank isn’t in a solid place. Some of the reports mentioned taking large provisions for loan losses, which is routine but still worth mentioning given the context. In some cases, non-GAAP metrics were to explain the quarter’s performance to shareholders. (Yes, a case can be made that non-GAAP metrics are valid indicators of a company’s health but the Securities and Exchange Commission is becoming increasingly concerned about their overuse and in some cases, abuse.) Even “Modest” Growth Works The point is, this article concentrates just on the CRE lending flow of the quarter and not how profitable those loans may be. But even banks that posted “modest” loan growth for the quarter, such as CoBiz Financial in Denver, CO, is still confident in the asset class and additional opportunities ahead. Said CEO Scott Page: Our construction lending portfolio is very active right now, and we’re getting really significant multi-draws as we move into the Colorado building season. These are from loans put on the books last year, and now these loans are through their equity component into the construction loan phase. This will give us a good baseline of growth for the balance of the year. So why are banks still eager to participate? Here, we don’t need to look to Q1 for an answer. As it has for the past several years, CRE remains one of the better investments on the market. “CRE Leads the Way” As such many banks noted that CRE lending was a top growth driver. SB Financial Group, based in Defiance, OH, reported record loan growth for the quarter of 14% from the previous month and over $65 million for the year to date, an improvement of nearly 13%. SB Financial’s loan growth was more diverse this past quarter compared to last year, according to CFO Tony Cosentino and commercial real estate led the way with $38.9 million in growth, followed by residential real estate of $17.9 million and C&I of $7.1 million. Atlanta, GA-based Suntrust Bank made the similar comments. “Commercial loan growth was driven by C&I and commercial real estate clients, while consumer loan growth was generally broad-based,” the CFO said. And when the CEO of Sandy Spring Bank in Rockville Md, was asked to elaborate on some of the drivers to continuing its current pace, the reply was: “I would say we’re looking, as we look forward, for commercial to continue, commercial real estate to be a key component and driver to loan growth, but not anything really different than what we have been producing here the last several quarters.” Richmond, VA-based Union Bankshares Corp. reported that the whole construction loan and land development was a big driver for loan growth. “We’re seeing our builders start to have better opportunities, and we are also seeing some commercial construction. … We had some stuff move out of construction, commercial construction, move into commercial real estate.” A Conservative Bank Perhaps the most interesting story came from Bank of The Ozarks in Little Rock, AK, which had what only could be described as a rockstar quarter.  Its Q1 net income of $51.7 million, or a 29.6% increase over the same quarter last year, was a quarterly record. The bank prides itself on its conservative underwriting, in fact (no need for regulators to step in with this bank, in other words). According to George G Gleason II, even with its highly picky lending criteria it still had businesses beating down the door. This has been an ongoing trend of the last couple of years, he said.

…more and more of our sponsors have come to us and says, look, we know your rates are little higher than the other guys. Your fees are higher, our legal costs are higher, your documents are a little tougher and your leverage requirements are lower, but you guys are so good at executing, you take so much transactional risk out of transactions we do with you and your speed of execution is so much better, we are willing to let you do all of our deals if you can do them all, or any of our deals you want to do.

This has created this tremendous surge in the growth of the bank’s portfolio, both funded and unfunded over the last several years, he said.