CRE Finance World Winter 2016
10
T
Continued Slow Growth in
Bank Construction Lending
he readiness of US banks to participate in the commercial
real estate lending market improved in 2015. Healthier
balance sheet positions, rising asset prices, and a
brightening outlook for fundamentals all contributed to
swifter matchmaking between lenders and their borrowers.
This progress did not occur in isolation, however. Lenders of all
stripes, including conduit participants and non-bank financial
institutions, were also more vigorous in their engagement with
borrowers. The result was observably higher risk-taking for banks
that, competing with other classes of lenders as well as with each
other, faced a practical choice of pushing the underwriting envelope
or ceding opportunities and market share.
In contrast with stabilized property lending, small- and medium-balance construction financing remained a weakly contested
segment of the market in 2015, largely free of competitive
pressures from geographically remote balance sheet lenders and
from the conduit. That continues to suit regional and community
banks perfectly well. Following the post-crisis drought in building
activity, opportunity knocks once again. As of Q3 2015, banks
have increased net construction lending for ten consecutive
quarters. The magnitude of the increases is measured however.
As compared to historic norms, subdued expansion in construction
lending reflects plodding improvements in the number of viable
small- and mid-cap development projects. The impact of higher
risk weights on the banking system’s construction lending capacity
is almost certainly a factor as well. The extent of its drag should
become clearer in 2016.
Cyclical Attention to Risk Fades
Data from the most recent slate of bank call reports and from
Chandan Economics’ independent mortgage data collection show
sustained trends in bank lending heading into the new year: both
small and large banks are growing their positions in commercial
real estate and construction; the lending market is increasingly
crowded and many banks are losing market share; to stave off that
competition, the risk profile of recently originated loans is often
markedly higher than for loans made just a few years ago; and, in
contrast with CMBS, drags from banks’ legacy debt are now a de
minimis consideration.
As in past cycles, the medium-term implications of banks’ increasing
risk tolerance are not perfectly observable—or heeded—at the time
of loan-making. Quite the opposite, the current profile of bank
activity suggests they are discounting their own stress testing
regimes in an unsurprising effort to remain competitive. Uneven
regulation across classes of lenders is a complicating factor in that
competitive landscape. Even as our risk models show deterioration
in marginal loan quality, improving property fundamentals and the
shrinking pool of legacy loans are supporting favorable inferences
about the future performance of today’s new exposures.
Bank Delinquency and Default Trends
The blended default rate on commercial and multifamily mortgages
held by banks—including loans 90 days or more delinquent and
loans in non-accrual—declined to just 0.8% in the third quarter of
2015, the lowest level since before the financial crisis. Excluding
apartments, the commercial property default rate fell to 1.0%, its
lowest level in more than seven years. The apartment default rate
is now just 0.3%. That is well below Chandan Economics’ estimate
of the long-term structural non-performance rate, centered around
0.5%. Five years earlier, banks’ multifamily default rate had peaked
at 4.7%, higher than for their commercial mortgages. At that time,
banks’ multifamily default rate was also significantly higher than
roughly comparable agency measures of distress, a difference
we attribute principally to selection bias in the apartment sector’s
lender-borrower relationships.
Chart 1
Default Rate for Bank Commercial and Multifamily Mortgages
Source: FDIC, Bank Call Reports, Chandan
Sam Chandan, PhD
The Wharton School and
Chandan Economists