Banks Dial Back CRE Lending as Loan Growth Slows to Two Year Low

Fewer Transactions, Construction Slowdown, Retailer Troubles Give Bankers Pause in First Quarter

By Mark Heschmeyer, April 20, 2017, Courtesy of CoStar

Reflecting the more modest pace of CRE sales volume this year than in the previous two, CRE lending growth by banks in the first quarter dropped to its slowest level of growth in two years, which should help federal banking regulators sleep better after warning about overheated commercial real estate lending.

The amount of CRE loans on bank books increased 7.7% in the first quarter, well down from the 11.6% growth rate posted in the same quarter a year ago, according to weekly Federal Reserve data.

Bankers attributed the compressed loan growth to several factors, including concerns over multifamily and retail property fundamentals, the aforementioned slowdown in sales transactions, and rising construction costs.

Those factors have some – but not all — banks examining their real-estate-related loan portfolios and proceeding with a little more caution.

“I would say we started moderating multifamily in certain markets a couple of years ago, taking a look at supply that was coming online,” said Susan L. Springfield, chief credit officer of First Horizon National Corp. (NYSE:FHN) in the company’s first quarter earnings conference call. “More recently, we’re paying close attention to hospitality and retail.”

Other banks also noted that they were limiting their lending to top-level malls and neighborhood strip centers anchored by grocery stores and other necessity tenants. And others were approaching it on a very, case-by-case, location-by-location basis.

However, no less an authority than Jamie Dimon, chairman and CEO of one of the nation’s largest banks, said he believes market concerns over the retail sector are overblown.

Responding to an analyst on the bank’s recent conference call by saying he thought such speculation was “way out of line.”

The retail business has always been “violent and volatile,” Dimon said, with half of retailers that were around 10 years ago, now gone.

“When you go to real estate, most of the real estate has nothing to do with retail. So, we do have some shopping centers, malls and buildings and stuff like that. But those are generally items that are well secured, not relying on single retailers,” he said.

Also, there have been no indications of increased retail real estate-related loan defaults, added Justin Bakst, director of capital market analytics at CoStar. At least not yet. Anchor tenant defections from shopping centers could put force many smaller inline retailers to go bust, which has the potential to send some loans into default, Bakst said.

“The smaller players just don’t have the balance sheets to withstand a market shock,” he said.

Slowing Property Sales Holding Back Some Lending

CoStar Group confirmed that first quarter of the year has seen a significant drop in property sales volume. CoStar has tallied $109.45 billion in CRE property sales in the first quarter. The results are still preliminary, but the total is still down 25% from the first quarter of last year. Multifamily deals are down 37% and retail property sales down 23%.

The totals so far represent reduced CRE property transaction volume of about $36 billion compared to the same quarter a year ago. And that reduction in deal activity is reflected in reduced bank loan origination volume this year, bankers noted.

Some Proposed Projects No Longer Pencil Out

Another factor that is putting a bit of a lid on some CRE loan volume growth is that increased material and labor cost have made some development projects less financially feasible, said George Gleason, chairman and CEO of Bank of the Ozarks (NASDAQ:OZRK), one of the nation’s most active CRE lenders during the recovery era. “This is not a widespread thing. But on the margin, it’s knocking a few deals out of the feasibility category that would have been built in a very feasible way at last year’s cost basis,” Gleason said.

Double-digit price increases for key construction materials pushed up construction costs, according to data through last month from the Associated General Contractors of America.

Among the most widely used materials in construction, there were price increases over the past 12 months totaling 19% for steel mill products, 17% for copper and brass, 8.8% for aluminum, 7.6% for gypsum products such as wallboard and plaster, and 7.3% for lumber and plywood. In addition, the price index for diesel fuel, which contractors use directly and also pay for through surcharges on the thousands of deliveries to construction sites, soared 35%.

That escalation in construction prices is curbing some new development — and cutting into banks’ fastest growing loan category last year. Bank’s C&D lending surged almost 14% in 2016, topping 13% growth in 2015.

Bankers Remain Eager to Lend

But while CRE lending growth has slowed, some banks are still expressing a willingness to up their levels. “We’re fairly optimistic about loan growth this year,” Kevin Howard, chief credit officer of Synovus Financial Corp. (NYSE:SNV), told analysts. “I think year-over-year last year we were at negative 2%. We’re thinking this year it’s more probably zero to low single-digit growth, its maybe 3% or so.”

The big unknown to that outlook is what impact rising bank borrowing rates may do to lending, added CoStar’s Bakst. “With the obvious time lag of bringing deals to close, we had the first real sign of a potential sustained rising interest rate environment,” he said. “Rising interest rates will almost always slow loan volume. But, it seems as though lenders are still cautiously optimistic. Unless we have some sort of unforeseen economic shock, I expect the second quarter to be stronger.”