Despite further interest rate hikes in 2022, banks appear well-positioned to continue issuing new loans and defending their position as a major financing source for commercial real estate.
According to the Mortgage Bankers Association, total commercial/multifamily loan outstanding increased to a record $4.05 trillion at the end of the third quarter, and the number is expected to hit a new high once the fourth quarter numbers are fully expanded. Commercial banks hold the largest share of that debt at $1.5 trillion—38 percent of the total market, compared to the 22 percent held by second-ranked agencies/GSEs.
Industry data shows that banks are well capitalized. Trillions of dollars in government stimulus produced historic deposit growth at US banks during the pandemic, while credit growth remains weak. according to a 2022 Banking Industry Outlook Report From S&P Global Market Intelligence, that dynamic created an estimated $3.72 trillion of additional liquidity on U.S. bank balance sheets as of June 30, 2021, and additional funds are expected to top $2.9 trillion by 2023.
“In 2022, I think capital remains available from banks, and they’re going to be aggressive,” says Mike Chase, senior vice president and managing director at Northmark’s Boston regional office. Much capital is available in the banking sector from community banks, middle market banks, national currency center banks and even international banks. However, their strategies regarding commercial real estate lending, the types of deals they are going after and how they price their loans can vary greatly, he adds.
Brandon Smith, managing director of JLL in Los Angeles, notes that banks are winning deals of 65 percent loan-to-cost or less, with pricing in the mid-100s to mid-200s. Some banks may extend this period to four or five years, which is beneficial for borrowers, while others are limited to a specific three-in-one structure—three-year periods and two one-year extensions. Most banks also require a 50 basis point to 100 basis point upfront origination fee, says Smith.
Some of the more aggressive banks are willing to take around 80 per cent on leverage for acquisitions, while others are closer to 70 per cent to 75 per cent. However, borrowers who are buying at very low cap rates are often constrained by debt service coverage ratio limits before they are constrained by leverage limits, especially in major markets such as Boston, New York City, and Los Angeles. Chase notes. For example, a 1.25x debt service coverage ratio on a property that is selling at a cap rate of 4 percent or less could put the leverage that a bank is able to do at 65 percent.
Banks favor relationships
Irrespective of the lending capacity, banks are battling some opposite currents in terms of competition and uncertainty in certain asset sectors. While banks are “ready to expand” thanks to strong sponsorships and relationships, many are selective on sectors that have been more negatively impacted by the pandemic, particularly hospitality, retail and office.
2021 was a record high year for Dallas-based Veritex Bank with nearly $2 billion in commercial and multifamily loan commitments. “When COVID hit, we made a conscious decision not to sit on the sidelines like many other banks,” says Bob Stone, executive vice president and managing director of commercial real estate lending at Veritex. The $10 billion regional bank took advantage of less competition and the ability to obtain more favorable loan prices.
Veritex has focused largely on financing industrial and suburban multilateral development in Texas. “The markets here are still very good and we are very active, but in 2022 we may not be as active as we choose and a little bit more,” Stone says. Specifically, the bank is looking at lease-up activity and how rising construction costs are playing out to deals it has in the pipeline. Veritex is also wary of the competition that is heating up back up. “We’ve seen real aggressive pricing and a lot of the positions are a little too cheap,” Stone says. Construction loans are now driven by SOFR-based pricing, and some banks are quoting rates at 1.95 per cent. “We haven’t chased deals so low,” says Stone.
Competition is also coming from non-bank lenders where there is a lot of liquidity. For example, some mortgage REITs pulled back on new origination activity after the start of the pandemic, while they focused on managing leverage and liquidity, said a director at Fitch Ratings’ North American Non-Bank Financial Institutions (NBFI) group. Chelsea Richardson noted. , “As a result, they now have more cash to operate than they have historically and have generated new loans over the past few quarters,” she says. NBFIs are looking at where they can get the best risk-adjusted returns, and like many other capital sources, there is a lot of interest in multifamily and industrial, she adds.
crime remains low
So far, bank credit departments have performed very well during the pandemic. According to MBA, loans and thrifts held by banks that are outstanding for 90 or more days or non-accrual stood at 0.69 per cent as of the third quarter.
Fitch Ratings recently noted global financial institution The article states that it expects to see a deterioration in loan asset quality in 2022 in the form of financial and policy support for banks and NBFIs. “The context for this is that asset quality numbers in terms of charge-offs are at their best in decades,” says Christopher Wolfe, managing director and head of Fitch Ratings North American Banks Group. “So, when we say we expect some level of downside, it is from continued lower credit losses,” he says.
This level of performance is difficult to sustain, much of which has been helped by a low interest rate environment and a relatively rapid rebound in the economy, Wolff noted. The Fed has indicated it will raise rates, which will put an additional burden on credit performance. “The reality is we are going to see some signs of credit decline emerge, but not immediately and not in a dangerous way,” he says.
Although smaller banks tend to have more concentrated exposure to commercial real estate, banks across the board have taken steps to improve diversification within loan portfolios. Large banks subject to CECL norms also started issuing reserves in 2021 as the economic outlook improved. CECL (Current Expected Credit Loss) is a new method for estimating allowance for credit loss issued by the Financial Accounting Standards Board (FASB), which requires financial institutions to estimate potential bad debt and adjust capital reserves accordingly. requires a forward-looking approach.
One issue that will continue to be at the fore in bank CRE lending decisions in the coming year would be uncertainty over the path of recovery and a more permanent turnaround in demand from property sectors such as hospitality, retail and office. “I don’t think it’s as much of a CECL issue as it is a question about long-term trends and how banks want to position the portfolio,” Wolff says.
Banks have a reputation as relationship lenders, and relationship banks will continue to play a vital role in lending in the year ahead. “In 2022, the office and retail market is going to grow. But banks are going to evaluate each transaction on their own, and a lot of that will come down to sponsorship and the strength of the relationship,” Chase says. “That’s really the key to bank lending in general. Banks tend to focus more on sponsors than some of their capital market counterparts.”