CRE borrowers are ready to benefit from strong bank liquidity in 2022

Despite looming interest rate hikes in 2022, banks appear well positioned to continue to provide new loans and defend their position as the primary source of commercial real estate funding.

Total commercial/multifamily debt outstanding hit a record $4.05 trillion at the end of the third quarter, according to the Mortgage Bankers Association, and those numbers are expected to hit a new high once that the fourth quarter figures will be fully accounted for. Commercial banks continue to hold the largest share of this debt at $1.5 trillion, or 38% of the overall market, compared to 22% held by agencies/GSEs far behind.

Industry data shows that banks remain well capitalized. Trillions of dollars in government stimulus have produced historic growth in deposits at US banks during the pandemic, while loan growth has remained weak. According to a Banking Sector Outlook Report 2022 According to S&P Global Market Intelligence, this dynamic has caused an estimated $3.72 trillion of excess cash to accumulate on U.S. banks’ balance sheets as of June 30, 2021, and excess funds are expected to remain above $2.9 trillion. dollars until 2023.

“As we approach 2022, I think banks’ capital is still available and they’re going to be aggressive,” said Mike Chase, senior vice president and general manager of Northmarq’s Boston regional office. There is a lot of capital available in the banking sector from community banks, middle market banks, national currency centers and even international banks. However, their commercial real estate lending strategies, the types of transactions they seek, and how they value their debt can vary widely, he adds.

Banks are winning contracts with a loan-to-cost ratio of 65% or less, with price spreads ranging from the mid-hundreds to the low 200s, notes Brandon Smith, JLL’s Los Angeles managing director. Some banks can extend the term to four or five years, which is advantageous for borrowers, while others are limited to a typical three-one-one structure – one three-year term and two one-year extensions. year. Most banks also charge upfront origination fees of 50 to 100 basis points, Smith adds.

Some more aggressive banks are willing to get close to 80% leverage for acquisitions, while others stick closer to 70% to 75%. However, borrowers buying at very low capitalization rates are often constrained by debt service coverage ratio limits before being constrained by leverage limits, especially in major markets such as than Boston, New York and Los Angeles, notes Chase. For example, a debt service coverage ratio of 1.25x on a property that sells at a cap rate of 4% or less could put the leverage a bank is able to do at 65%. .

Banks favor relationships

Despite their ability to lend, banks are facing cross-currents in terms of competition and uncertainty in certain real estate sectors. Although banks are “ready to stretch” for strong sponsors and relationships, many are still selective about sectors that have been more negatively impacted by the pandemic, including hospitality, retail and offices.

2021 was a record lending year for Dallas-based Veritex Bank, with approximately $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 general manager of commercial real estate lending at Veritex. The $10 billion regional bank has benefited from less competition and the ability to secure more favorable lending rates.

Veritex has largely focused on financing multi-family industrial and suburban developments in Texas. “The markets here are still very good and we’re very active, but we may not be as active in 2022 as we pick and choose a little more,” Stone says. In particular, the bank is monitoring leasing activity and how rising construction costs are playing out for transactions it has in progress. Veritex is also wary of the warming competition. “We’ve seen really aggressive pricing and a lot of situations are a little too cheap,” Stone says. Construction loans are now governed by SOFR-based pricing, with some banks offering rates as low as 1.95%. “We didn’t chase deals that low,” adds Stone.

Competition also comes from non-bank lenders where there is a lot of pent-up liquidity. For example, some of the mortgage REITs pulled back on new origination business after the onset of the pandemic as they focused on managing leverage and liquidity, notes North Group Director Chelsea Richardson. American Non-Bank Financial Institutions (NBFI) from Fitch Ratings. . “As a result, they now have more liquidity than before and have started to originate new loans again in the past two quarters,” she says. NBFIs look for where they can get the best risk-adjusted returns, and like many other sources of capital, there’s a lot of interest in multi-family and industrial buildings, she adds.

Arrears remain low

So far, bank loan portfolios have weathered the pandemic extremely well. Loans held by banks and savings 90 days or more past due or unaccounted for were down 0.69% in the third quarter, according to the MBA.

Fitch Ratings noted in a recent Global Financial Institutions article that he expects to see a deterioration in the quality of lending assets for banks and NBFIs in 2022 as fiscal and political support wanes. “The context is that the asset quality write-off numbers are the best we’ve seen in decades,” said Christopher Wolfe, managing director and head of the North American Banks group at Fitch Ratings. “So when we say we expect some level of deterioration, it’s coming from unsustainable credit losses,” he says.

It is difficult to maintain this level of performance, which was largely helped by the low interest rate environment and the relatively rapid rebound in the economy, notes Wolfe. The Fed has indicated that it will raise rates, which will further weigh on loan performance. “The reality is that we are going to see signs of credit deterioration, but not right away and not alarmingly,” he says.

Although smaller banks tend to have more concentrated exposure to commercial real estate, banks as a whole have made progress in improving diversification within loan portfolios. Major banks that have been subject to CECL rules have also started releasing reserves in 2021 as the economic outlook improves. CECL (Current Expected Credit Losses) is the new methodology for estimating provisions for credit losses issued by the Financial Accounting Standards Board (FASB) that requires financial institutions to take a forward-looking view in estimating potential bad debts and adjusting capital reserves accordingly.

Uncertainty on the path to recovery and more permanent shifts in demand for real estate sectors such as hospitality, retail and office will be an issue that will remain at the forefront of lending decisions for banks on CRE in the coming year. “I don’t think it’s as much a CECL issue as it is questions about longer-term trends and how banks want to position their portfolios,” Wolfe says.

Banks have a reputation for being relationship lenders, and relationships will continue to play an important role in bank lending in the coming year. “As we approach 2022, the office and retail market will grow. But banks will assess each transaction individually, and a lot of that will depend on the strength of the sponsorship and the relationship,” Chase explains. “That’s really the key to bank lending in general. Banks tend to be more sponsor-focused than some of their capital market counterparts.”

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