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CRE Finance World, Summer 2013

A publication of Summer issue 2013 sponsored by CRE Finance World Summer 2013 33 Figure 5 Loans Held on Bank Balance Sheets Source: Chandan Tracking the vagaries of the mixed economic recovery and a formidable regulatory environment, underwriting standards are adjusting unevenly. Dislocations are still a feature of the commercial real estate capital markets. Not every commercial real estate borrower who merits credit can secure financing. That inhibits economically efficient property sales, price discovery, and the market’s refinancing capacity. At the same time, overweighting of banks and other lenders to the safest assets — at least in terms of asset and market liquidity — has seen underwriting standards erode in segments of the market that are flush with capital inflows. The credit risks that are seeping into new lending are along dimensions where the industry is less attentive, including the influence of interest rate market manipulation on capital flows and asset values. In the context of rising interest rates, the trend in cash flow assumptions and the increasing prevalence of interest-only and partial interest-only loans are leading indicators of risk mispricing and clustered defaults at maturity. In the Q1 2013 Survey of Commercial Real Estate Lender Sentiment, balance sheet lenders overwhelmingly believe that origination activity will continue to grow during the next year. With increasing frequency, they also site rising competition that is eroding each lender’s market share. In an effort to hold that share, credit quality is coming under pressure. Underwriting to in-place cash flow remains the norm. Lenders report their willingness to accept lower debt yields, as well as higher loan-to-value ratios and lower debt service coverage ratios, even as they work to hold the line on asset and borrower quality and asset location. Figure 6 Qualified Upside for Smaller Banks in CMBS Recovery For some lenders, including smaller regional and community banks, income growth is lagging headline trends. Located outside of the largest metro areas, banks that are struggling to recover their full capacity are often saddled with small balance loans backed by assets that have been slow to recoup lost value. Modifications have been the order of the day, but these institutions also experience a high rate of recidivism on troubled debt restructurings. Reengagement in commercial real estate and construction lending is a risk management challenge and a challenge in the supervisory relationship, as well. A rise in CMBS issuance will prove a mixed blessing for banks focused on small- and mid-cap assets. Conduit financing has the potential to improve liquidity and price discovery across a diverse range of assets. As a capital markets phenomenon, that will add buoyancy to prices independent of fundamentals. At the same time, competition for higher quality lending opportunities and the State of the Banks


CRE Finance World, Summer 2013
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