Federal Regulators Warn US Bankers about their CRE Lending and Relaxed Underwriting

Most Bankers are bullish and like what they see in CRE lending Prospects

US Bankers appear to have selective amnesia as it relates to their ballooning CRE loan portfolios. Recently the FDIC issued a “warning” to the CRE lending community “prepare to hit the brakes and slow down their commercial real estate lending originations should conditions be warranted”.

In the third quarter of 2015, US Banks had steadily increased total CRE loans outstanding to $1.8 Trillion, exceeding the previous lending peak at the end of the second quarter of 2007 by over $170 Billion.

CRE loan underwriting standards have eased over the past three consecutive years, according to the US Banking statistics. So much, the FDIC last month issued a warning to Banks, directing them to employ prudent risk management policies for their commercial lending. The FDIC regulators also added they would pay close attention to Bank CRE lending practice in their 2016 audits. The last time the FDIC issued a memo regarding CRE lending practices was in 2005 and again in 2010. The memo in 2010 addressed the minimum acceptable cap rates the regulators would accept in the review of the Banks’s portfolio. If the cap rate used to qualify the loan was below FDIC minimums, the value of the Bank’s portfolio would be adjusted triggering additional capital reserves.

CRE market fundamentals and pricing are strong and Bankers in general say they are reluctant to leave the party while the party is still going strong. Does this sound vaguely familiar to the rhetoric we heard in 2006 and 2007? Did we not learn our lesson or are we destined to repeat history over and over again until we are regulated right out of the industry as the residential market has done? Cap Rates below 3% and 4% on assets which are considered prime real estate are not sustainable.

As it relates to the question on the health of the CRE market lease ups are modeled or better than modeled. The permanent market is taking out loans earlier than the Bankers have experienced. Bankers still believe the market is pretty strong and healthy. We have all heard this before as well! The CEO of BankUnited told analysts the regulators warning doesn’t take into account the differentiation in the CRE property types and markets. The regulators only have one category; Commercial Real Estate, lumping all commercial real estate into one category. Some US Bankers feel the regulators are looking at more speculative areas of commercial real estate and getting nervous about the overall category.

The Bankers feel the key is to manage where you lend, what type you lend on and the underwriting of the loans. Bankers do generally agree they are going to be a lot more selective in 2016. In order to offset the rising values Bankers have been looking at what the property’s value was in 2009 and 2010, and deciding on how much they will lend relative to the current value.

As I have discussed in my classes, the Regulators, not the Bankers are the ones who dictate the Bank’s overall lending criteria – whether it is through a “warning memo” or during the Regulators annual reviews of the Bank’s portfolio.  The Bankers will be making their own internal adjustments and the public could be caught holding the bag by not adjusting to the new lending guidelines.

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 Joseph R. L. Passerino, Managing Director | Broker
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