Largest Banks Casting Wary Eye on Heated Commercial Real Estate Lending Market Article originally posted on CoStar on April 19, 2018 Despite record liquidity, demand for commercial real estate loans softened in recent months, leaving eager lenders chasing fewer borrowers. As a result, competition among lenders has ratcheted up noticeably with loan prices compressing. In fact, deal pricing and structures have gotten so competitive, many of the nation’s banks, including its 25 largest cumulatively, are starting to back off from commercial real estate lending. Federal Reserve data in February first revealed the trends among banks, which held up through the entire quarter. Now in the past week, bank executives have started providing color and analysis to the data in their first quarter earnings conference calls. First the numbers. The total amount of commercial real estate loans on bank books increased $26.4 billion to $2.1 trillion through the first quarter from year-end, according to Federal Reserve data. However, real estate loan exposure actually pulled back at the nation’s 25 largest banks, dropping off about 1% on an annualized basis. Those 25 banks account for 33% of commercial real estate bank loans outstanding. Meanwhile, the rest of the nation’s domestic banks continued to grow their loan portfolios by 7% on annualized basis. The appreciation that has occurred in property values has contributed to a lower level of inventory available in the market. Deal volume is also down as investors are taking a more cautious stance in the current environment. Some banks reported that a majority of their first quarter commercial real estate loan production consisted of refinancings. And with interest rates beginning to climb, some bankers expect refinancing volume could slow down. Executives with Bank of America and JPMorgan Chase were among those who noted that pricing and loan structures were getting to levels at which they were not comfortable matching. Also, the extended duration of the current cycle also has bank executives proceeding cautiously. “It’s not just pricing, it’s just generally we continue to be very selective and cautious given where we are in the cycle,” said Marianne Lake, CFO of JPMorgan Chase. “In the CTL [credit tenant lease] space and commercial real estate space more generally that’s where the competition really has stepped up very significantly and that is where pricing has become fiercely competitive…and is in compression.” Pricing is 20 to 30 basis points lower than what it was six months ago, bankers noted. Terry Dolan, vice chairman and CFO of U.S. Bank, said, “The risk-reward dynamics in commercial real estate remain unfavorable in our view, particularly in multifamily and certain areas of commercial mortgage lending. That discipline is influencing decisions to not extend credit on unfavorable terms; and [it is] adding to the elevated pay down pressures driven by customers accessing the secondary market.” Part of the slowdown also stems from an intentional decision on the part of banks to balanc their loan portfolios by shifting away from commercial real estate lending in favor of boosting their overall commercial business lending, bankers said. “We had our strongest quarter ever in terms of loan production with a record $1.1 billion in new loan commitments and new loan disbursements of $764 million. We are also very pleased with the improved production mix of 45% commercial real estate, 31% C&I [commercial and industrial] and 24% consumer, with the majority of our production this quarter coming from our non-CRE categories,” said Kevin S. Kim, president and CEO of Bank of Hope in Los Angeles. “We believe these results reflect the benefits of our investments over the last year in our C&I [commercial and industrial] and residential mortgage platform and talent.” In the past, closer to 60% of the bank’s loan production volume would have come from commercial real estate. This quarter the bank saw its loan totals decrease 2% in multifamily assets and 1% in retail assets. Even smaller regional banks are taking that approach. Alabama-based ServisFirst Bank reported commercial and industrial business lending growth and a reduction in commercial real estate loans. Thomas Broughton, CEO of the bank, said the decrease resulted primarily from a reduction in real estate construction loan balances. “We want C&I to be the predominant asset class of our balance sheet; it’s certainly more predictable,” Broughton said. “We think it has lower loss potential in a downturn.” Where commercial real estate lending activity did see a slight pickup was from banks in the Northeast. “For CRE we saw a little bit of more growth in New Jersey and upstate New York and in metro or New York City,” said Darren King, executive vice president and CFO of M&T Bank. That growth was coming from continued demand for warehouse and multifamily space and growth in assisted living and skilled nursing. “Warehouse capacity is more in demand because that’s how [retail] customer needs are being fulfilled,” King said. “And then one of the other macro trends that continue is people moving back into urban centers, particularly the millennials and empty nesters, and that’s driving demand for multifamily.” What bankers were reporting in their earnings calls synced up with what the Federal Reserve is reporting in its latest survey of economic conditions, referred to as the beige book, released yesterday. Banks in the New York District reported strong housing demand but with volume constrained by low and declining inventories. Small- to medium-sized banks in the District reported higher demand for commercial mortgages, and C&I loans. Banks in the Atlanta District also noted that commercial acquisitions slowed due to difficulties over pricing. Dallas bankers, though, noted that overall loan volumes and demand increased at a faster pace over the past six weeks, with markedly stronger growth in loan volumes seen in commercial real estate.