New data and commentary from federal financial regulators are pointing to signs of increased risks in CRE lending.
Notably, the amount of delinquent multifamily and owner-occupied property loans on the books of U.S. banks increased in the Q4-17 of last year, according to the FDIC.
And while the increases and total volumes are small, the uptick marks a change in the trend after multifamily delinquency levels hit the lowest mark ever recorded by the FDIC. The FDIC data follows the Fed’s latest Monetary Policy Report that noted growing vulnerability in the commercial real estate sector.
“Valuation pressures continue to be elevated across a range of asset classes, including equities and commercial real estate,” the Fed noted.
“In a sign of increasing valuation pressures in CRE markets, NOI (net operating income) relative to property values (referred to as capitalization rates) have been declining relative to Treasury yields of comparable maturity for multifamily and industrial properties. While these spreads narrowed further from already low levels, they are wider than in 2007,” the report noted.
FDIC chairman Martin J. Gruenberg said earlier this month that the interest rate environment and competitive lending conditions continue to pose challenges for many institutions.
“Some banks have responded by ‘reaching for yield’ through investing in higher-risk and longer-term assets,” Gruenberg said. “Going forward, the industry must manage interest-rate risk, liquidity risk, and credit risk carefully to continue to grow on a long-run, sustainable path. These challenges facing the industry will remain a focus of supervisory attention.”
Gruenberg noted in the FDIC’s recent 2017 annual report, “By many measures, stocks, bonds, and real estate are richly priced. Stock price-to-earnings ratios are at high levels, traditionally a cautionary sign to investors of a potential market correction.” “Bond maturities have lengthened, making their values more sensitive to a change in interest rates. As measured by capitalization rates, prices for commercial real estate are at high levels relative to the revenues the properties generate, again suggesting greater vulnerability to a correction.”
Meanwhile, the total amount of commercial real estate loans held by U.S. banks and savings and loans continued to swell. The total amount of CRE loans outstanding held by FDIC-insured institutions increased 1.2% to $2.13 trillion at year-end from the third quarter. Total loan amounts outstanding increased in every category of CRE lending broken out by the FDIC.
Meanwhile, real estate lending by banks increased in some areas while moderating in others. The rate of increase for nonresidential and multifamily were below the rates at which those categories grew on average last year.
With the business cycle, the credit cycle and the CRE cycles all peaking, the risks of acquisition, financing and/or refinancing have also increased. Speculation of a recession brought on by increased interest rates, newly implemented tariffs, the $1.3 trillion omnibus budget, and other risk contributors emanating from Washington add fuel to the fire of uncertainty.
In this environment it pays – literally – to have excellent counsel on your side of the table. We modestly suggest that we qualify.
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Michael Green is a Commercial Loan Originator for the Counsel Mortgage Group®, LLC.
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