GeneG posted on October 29, 2009 15:45
Banks continued to report further erosion in commercial real estate-related credit quality and weak or declining loan demand in their quarterly earnings reports to investors and monthly lending reports to the Federal Reserve Bank. Rising loan payment delinquencies, declining property values, rising vacancies, the lack of deals and consumer spending were often noted as the primary drivers of credit-quality deterioration. In addition, the quality of loan applicants and lack of confidence on the part of borrowers in their own assets were also said to be deteriorating.
So why aren't banks seemingly more worried? The answer from many of them is because this isn't residential real estate. If a homebuilder or homebuyer gets in trouble, the loan ends up in trouble because there is no cash flow to support the deal. That's not the case with commercial real estate, according to banks.
"Despite the difficult economic environment, [our] portfolio performance remains adequate. The commercial real estate portfolio also continues to perform reasonably well overall," Tom Freeman, chief risk officer of SunTrust Banks Inc. said in the banks quarterly earnings conference call. "While I'm not able to tell you what the future holds in terms of absolute performance in this portfolio, I can tell you that we believe this business will continue to perform adequately. One of the reasons for this view is our commercial real estate portfolio is largely owner-occupied. Rental revenue from the property is not the primary source of debt service; rather the underlying business service is the debt."
C. Dowd Ritter, chairman and CEO of Regions Financial Corp. echoed that sentiment: "While manageable, the effects of the economic downturn are, to a greater degree, extending beyond our problematic homebuilder, Florida home equity second lien and condominium portfolios; these assets still account for a sizeable element of overall non-performers. However, other commercial real estate credits such as loans secured by income-producing properties explain the bulk of the third quarter's [nonperforming loan] inflow. Keep in mind, there is greater cash flow associated with loans on income producing property, which improves our ability to restructure the credit and return it to performing status."
This suggests that banks believe that commercial real estate-related problems pose less of a risk than what they have seen in their homebuilder and condominium portfolios, and that they expect to have greater ability to restructure loans and return some of them to performing status. In the respect, banks suggested that the falling appraisal values were less important than the underlying strength of the asset and borrower's ability to make payments and keep the loan current.
Many banks said they were planning on restructuring most maturing commercial real estate debt.
"Obviously we're seeing [commercial real estate] value diminishing, cap rates are expanding. There is pressure on rent rates and obviously on tenancy," said John Ciulla, executive vice president and chief credit risk officer of Webster Bank. "We're looking at our portfolio as a sort of portfolio to hold now. Obviously the capital markets aren't there for refinancing, so we're again, cautiously optimistic as we head into sort of the teeth of the recessions effect on the commercial real estate category. And we're looking prospectively at our maturities to try and underwrite them and make sure that the tenancy and the lease rates cover reasonable debt service and refinancing for us internally."
Tom Tolda, executive vice president and CFO of East West Bancorp, Inc., said the economy may not come back in 2010 but there are buyers out there for banks' CRE assets. "To me, I think it's going to get worse. But the fact is, even as our commercial real estate loans having a little bit more pressure going into 2010, we wouldn't have the kind of massive losses that we had experienced in the construction and land portfolio. And we feel that the loss content probably would be substantially lower, and in fact, if you look at the charge-off that we have taken, we have actually sold many loans and resolved many problem credits that have not even been delinquent."
A handful of small and mid-sized banks even said they saw opportunities to take advantage of lack of lending in the marketplace.
"We continue to see opportunities to offer mortgages for owner-occupied properties as traditional sources of takeout financing. Insurance companies and the like have been absent from the market," said Ted Cecala, chairman and CEO of Wilmington Trust Corp. "The length of the commercial mortgage loans that we are making is typically around five years. We do not offer the long-term structures that were historically provided by traditional commercial mortgage lenders. Over half of our portfolio is composed of owner-occupied properties. This is meaningful because we believe that overtime, owner-occupied properties are more stable."
Still many banks, including some of the nation's largest, continue to avoid new commitments. Fifth Third Bancorp reported that it continues to suspend lending on new non?owner occupied properties and on new homebuilder and developer projects in order to manage existing portfolio positions. The bank holding company said this is prudent given that it does not believe added exposure in those sectors is warranted and given the expectations for continued negative trends in commercial real estate.
KeyCorp and PNC Financial Services Group Inc. both said their primary lending activities in commercial real estate continue to be extending and modifying existing credits given the lack of liquidity and refinancing options available in the market. They expect loan extensions and modifications to continue to run high for the remainder of the year. Primary refinancing activity continues to occur in the multifamily space, with Fannie Mae, Freddie Mac, and FHA agencies financing these assets.
Additional comments from bank executives in their quarterly earnings calls follow and are indicative of the general trends reported by most lenders.
Stepped Up Review of CRE Exposures
Because of our concern over the pace of deterioration, and due to our concern about the weakening environment, especially for commercial real estate, we embarked upon a targeted portfolio review of our commercial real estate loan exposures much like we did with the residential development portfolio we completed late last year. We concentrated upon those segments of the portfolio where the weakness was coming from. During the quarter, we reviewed approximately 50% of the entire banks loan portfolio including substantially all commercial real estate loan exposure over $500,000 and most exposures prior to November 2007. Our outlook for the fourth quarter is that nonperforming loans will continue to grow, but not at the same rate as we experienced in the third quarter. Property values may have bottomed, yet market place demand and employment remains anemic and will result in additional defaulted loans.
Kevin Killips, CFO of PrivateBancorp Inc.
Lower Refinance Risk
Generally speaking, we expect that it will be challenging to obtain financing for commercial real estate in the next year and banks are not actively lending and also, real estate valuation remains low. However, the refinanced risk is low for our commercial real estate loans as we have single-digit maturities for each of the next few years. Additionally, due to the original longer term of our commercial real estate loans, these loans are coming due shortly are well seasoned. Further, our commercial real estate loans are amortizing loans where the borrowers have continued to make principal payment throughout the loan term.
Dominic Ng, chairman, president and CEO of East West Bancorp Inc.
Extracting More from Borrowers
The loans that we booked in the quarter from a geography standpoint are -- the vast majority of them are in our footprint, mostly in the New Orleans and New Jersey, New York City location. That's where most of our portfolios -- where most of our portfolio is located. We are looking for larger down payments, obviously with larger equity positions in the real estate. It's probably, I'd say probably at an average, probably around a third down. We actually pushed for 40% down if we can get it. And that's with personal guarantees. Without personal guarantees, we would expect a larger down payment. And we're talking about current appraised values, not past appraised values.
Gerald Lipkin, chairman, president and CEO of Valley National Bancorp
No for Retail; Yes for Multifamily; Maybe for Office
The retail side is, I think, still a little bit of an open question and largely tied to the economy and how the economy progresses over the next couple of quarters. While we've shown a bit of an uptake in nonperforming loans and charge-offs in retail, we're modestly encouraged by the delinquency numbers, which have stayed pretty flat. The retail portfolio is more highly correlated to the residential markets and therefore we've seen somewhat more weakness in the four states that have been hardest hit on the residential side, namely Florida, Nevada, Arizona, and California. But we think that - I wouldn't call it necessarily turning the corner, but I do think we've seen a little bit of modest improvement in the early stage side on retail.
Multifamily is a sector that we continue to believe will have relatively modest loss content in it, but clearly there are higher nonperforming loans and some migration there, again highly correlated to the four states that I mentioned earlier. But absorption rates continue to be decent in most parts of the country and while concessions abound, I think the general view is this is more of a timing issue, I think, than an ultimate loss situation.
Office is always a laggard and not a huge portfolio for us. A large portion, 30% plus, is in medical office building, which we think currently is performing well and we expect to continue to perform well.
Charles S. Hyle, executive vice president, chief risk officer of KeyCorp
By Mark Heschmeyer/Costar Advisore Newsletter/10.28.2009