CRE Loans: Are Underwriting Standards Slipping?
Kuehner-Hebert, Katie, American Banker
In the 1980s developers were building scores of skyscrapers, strip malls, condominiums - just about anything - on pure speculation that tenants would follow. Lenders were all too happy to help.
Then the bubble burst. Buildings sat half empty, and many banks with defaulted loans to developers on their books found themselves in deep trouble.
Now commercial real estate concentrations have again reached record levels - roughly 28% of community banks' assets as of March 31. To make sure history doesn't repeat itself, regulators are sounding the alarm, cautioning bankers not to succumb to pricing pressures and weaken underwriting standards.
Federal Reserve governors have issued warnings and revealed that the Fed is drafting "best-practices" guidelines on commercial real estate lending.
The Federal Deposit Insurance Corp. has put out its own best- practices guidelines on CRE lending and hosted teleconferences and roundtable discussions, reminding banks to ensure that the credits do not sour. The FDIC is also requiring banks that focus on such lending in the fastest-growing markets to document how they analyze the risks they face and prepare for bumps.
Some bankers say regulators should not worry, because they have maintained stringent underwriting standards. Others, taking the warnings to heart, have scaled back in this business or ramped up in others to balance out the risks.
According to the Fed, growth in CRE lending at banks with assets of less than $1 billion accounted for virtually all of their asset growth in 2003 and 2004. The CRE growth alone totaled nearly $32 billion last year.
The profitable business is especially popular among community bankers, who think their relationships with customers give them an edge over larger banks that focus on retail banking and corporate lending.
The Fed is quick to emphasize that current underwriting standards are much better than in the 1980s, and that banks are making fewer loans for pure spec development. Still, in recent surveys of senior loan officers, the Fed has learned that standards may be weakening.
In a June 3 speech to the Conference of State Banking Supervisors in San Antonio, Fed Governor Mark W. Olson said that the regulator has seen signs that standards are deteriorating as a result of strong competition and tight spreads. Several days later Fed Governor Susan Schmidt Bies echoed his comments at an American Bankers Association conference in Chicago for chief financial officers.
"At a recent Risk Management Association roundtable, several bank appraisers conceded that they are pressured to make deals on the assumption that exceptionally strong performance will continue indefinitely," Ms. Bies said.
Campbell Chaney, an analyst at Sander Morris Harris in San Francisco who used to be a Fed examiner, listed other ways some banks have loosened standards: making loans with higher loan-to-value ratios, accepting lower debt-coverage ratios, and extending loan payment terms, including stretching payment due dates from one month to two months or longer.
Though each of these measures may be acceptable individually, combined they could contribute to problems down the road if borrowers run into trouble, he said.
If underwriting standards are weakening, it is mainly because of competition. Community banks are under pressure to lend more, but commercial and industrial loan demand has not recovered fully and larger banks are winning more retail business. So small banks want as much of the CRE lending pie as they can get while demand for such loans is still high.
Frontier Bank in Everett, Wash., a subsidiary of the $2.4 billion- asset Frontier Financial Corp., has a 697.5% ratio of commercial realty loans to Tier 1 capital; the median for banks nationwide is 156%. But Frontier's board believes it is doing all the right things to mitigate risks, chief executive John J. …