Appraisal ManagementCommercial Appraisals

Banks’ Loss Rates for Commercial Real Estate Fall

By June 23, 2016 January 20th, 2020 No Comments
CRE

Loss rates on banks’ commercial real estate loans eased in the first quarter after hitting their highest rate in more than a year as 2015 ended, according to data from Sageworks, a financial information company.

In the first quarter, annualized net charge-offs represented 0.02 percent of average CRE loan balances, following a 0.14 percent loss rate in the fourth quarter, according to the data from Sageworks Bank Information, an online data platform.

The higher loss rate in the final quarter of 2015 came as regulators pledged fresh scrutiny of potential risks associated with CRE lending, noting banks had loosened underwriting standards and restrictive covenants, had extended maturities and interest-only payment periods, and had limited guarantor requirements.

Earlier in 2015, loss rates had ranged from 0.02 percent to 0.07 percent. CRE loss rates peaked at 0.90 percent in the December 2009 quarter as banks suffered losses tied to a surge of defaults on commercial mortgages and construction loans that had been made when demand and operating income for properties were much higher.

Why was there a lower loss rate in the most recent quarter?

Senior Risk Management Consultant Rob Ashbaugh of Sageworks said it’s unclear what exactly led to the lower loss rate in the most recent quarter, adding that it was possibly tied to stronger underwriting post-recession. He noted that financial institutions incur losses once they measure actual updated appraisals against the current loan marks. In addition, he said, rents and values are relatively strong currently. “If delinquencies and nonaccruals are low, then that could mean the market is strong,” he said.  “Remember, though, the regulators are saying CRE guidelines continue to be looser due to increased CRE competition among banks of all sizes.”

“When you do commercial real estate lending, it’s all about lending to cash flow – do the borrowers have the cash flow to cover it, or if you’re in construction, do you have the tenants in place? Cash flow’s pretty good right now, and that’s why CRE is sort of taking off,” Ashbaugh said.

Indeed, healthy borrower trends, low-interest rates and competition for business led banks to boost their commercial real estate lending activity in 2015. “Banks have been lending at interest rates that are very low, but they’re not making a lot of money because there is a small spread, or the difference between the rates they borrow at and the rates they are able to lend at,” Ashbaugh said. “As a result, banks have been trying to maximize spread wherever they can.”

CRE loss rates

In December, the Federal Reserve, Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency in a joint statement said they had “observed certain risk management practices at some institutions that cause concern, including a greater number of underwriting policy exceptions and insufficient monitoring of market conditions to assess the risks associated with these concentrations.”

“Historical evidence demonstrates that financial institutions with weak risk management and high CRE credit concentrations are exposed to a greater risk of loss and failure,” regulators said.

Regulators in December said indicators of asset quality weren’t implying weaknesses in CRE loan portfolios. However, Ashbaugh said the threat of a recession in the next few years warrants some caution.

In March, Comptroller of the Currency Thomas Curry noted the banking industry had been responsive to initiatives in areas such as commercial real estate concentration, leveraged lending, and energy lending, but he did not elaborate.

Ashbaugh said lenders and regulators are watching for any threat to property incomes. “It’s when you see that drop off – when stores aren’t expanding or you’re seeing stores decide not to go into new markets, for example – that’s where the income for properties can be at risk.”

Have you evaluated your bank’s loss or gain rates for CRE loans? If you’re looking to improve your appraisal management process, don’t hesitate to let us know. We can help.

 

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Guest Blog Post Written By: Mary Ellen Biery, Research Specialist, Sageworks