Commercial Real Estate: the Next Challenge?

After considerable contraction after the 2008 crisis, Commercial Real  Estate (CRE) lending began growing again in earnest in 2013, then began to slow down again in 2015. It continued to slow until 2019. Today, topping $2.4 trillion, CRE loans at U.S. banks are at an all time high.

The largest subcategory of CRE, non-farm, non-residential real estate, was up 4.6% at the nation's banks during the 12 month period ending 9/30/2019. It currently stands just shy of $1.5 trillion. While most banks hold a portion of CRE loans, too much CRE concentration (or of any concentration) could put a bank at risk in a market downturn.

Each bank has its own written policy relating to diversification and underwriting standards. They must also establish sufficient loan loss allowances and conduct periodic reviews to identify problem assets. For the most part, these internal policies and procedures are sufficient to keep problems at bay.

However, as we know all too well, there are exceptions. In ordinary circumstances, these exceptions affect one institution that has made some bad decisions. In more dire cases, hundreds of banks are harmed, or closed. (During the Savings and Loan crisis of the 1980s, more than 1,600 banks were shuttered and during more recent  Recession, we lost another 500.)

These events had three things in common: greed, inadequate supervision and severe myopia. The second crisis also highlighted the extremely short memory of the American public. In fact, we already see similar complacency setting in  today that preceded those events.

That's why it helps to have an unbiased, independent, third party to be on the constant lookout for cracks. This week we are looking at CRE lending. Specifically, banks with high concentrations, high growth and high levels of bad CRE loans. While these factors do not automatically translate to impending problems, they must be monitored.

Due to the surplus in multi-family and industrial properties, not to mention that of retail (JRN 36:30), CRE seems a good place to begin after the shopping season finished. We will continue with other categories in coming issues.

The 53 banks listed on page 7 have three things in common:

• Commercial real estate (CRE) loans represent at least 25% of total loans;
• CRE loans increased by a minimum of 10% during the 12 months ending September 30, 2019; and
• At least 2.25% of those CRE loans are 90 days or more past due.

This DOES NOT mean the banks are in trouble. In fact, as you can see many are rated 5-Stars or 4-Stars by Bauer, which examines the complete financial picture and history of the institution. Standouts include: 4-Star First National Bank of Ottawa, IL, a bank with a history spanning more than a century and a half. FNB of Ottawa decided in early 2018 to open a dedicated loan production office. As a result, its CRE loans grew more than 80% during the 12 month period noted.

5-Star Live Oak Banking Company, Wilmington, DE's CRE loans grew 57½% during the same time-frame, but growth is expected as this bank is only 12 years old.

Delinquent CRE loans at 4-Star National Bank, Andrews Texas represent 11% of its CRE loan portfolio. While roughly one-third of the bank's loans are currently in CRE, over 85% of all its delinquent loans are in CRE. That could be an indication that National Bank needs to improve CRE underwriting.

Two other banks listed have CRE loans representing more than 75% of total loans. They are: 4-Star PrinsBank, Prinsburg, MN and 3½-Star Valley Bank of Nevada, North Las Vegas, NV. In each case, delinquent CRE is at or below 3%. Valley Bank of Nevada has other problematic loans too, though as evidenced by a higher total delinquency to asset ratio.