Banks Put the Brakes on Commercial Real Estate Lending

U.S. banks are reining in their commercial real estate lending across most property types as they get squeezed between rising interest rates and competing nonbank lenders offering low-cost loans.

The overall decline in total mortgage loans made by banks in the third quarter helped slow the buildup of commercial property loan portfolios on their books, according to the Mortgage Bankers Association.

It's the first sign of a slowdown in real estate lending by banks this year following the end of an extended period of ultra-low interest rates as the Federal Reserve has steadily increased borrowing costs and signaled it plans to keep raising rates.

"Borrowing and lending backed by commercial and multifamily properties decreased 3 percent during the third quarter, and was 7 percent lower than a year ago. Rising interest rates took some wind out of the market's sails," said Jamie Woodwell, vice president of commercial real estate research for the Mortgage Bankers Association in a statement accompanying the group's quarterly survey of commercial/multifamily loan originations by its members.

The rising cost of borrowing money is damping some demand for new loans. Investors are also taking advantage of low projected rates of return on commercial real estate and higher prices to sell properties and pay off their loans before rates rise and property price growth softens, banking officials said.

Woodwell said the commercial mortgage-backed securities and bank lending markets were the hardest hit, while lending backed by multifamily properties and government sponsored enterprises Fannie Mae and Freddie Mac grew. Some rating agencies now project commercial mortgage-backed securities loan volume will be lower than in 2017.

Compared to a year earlier, a decline in third-quarter loans for health care and retail properties led the overall decrease in commercial/multifamily borrowing volumes, according to the association.

By property type, there was a 55 percent year-over-year decline in the dollar volume of loans for health care properties; a 28 percent decrease for retail properties; a 19 percent reduction for hotel properties; and a 17 percent drop for office properties.

One of the few bright spots in the quarter for finance companies was that lending for multifamily properties from both banks and the government sponsored enterprises grew, as did lending for industrial properties. Loan originations last quarter increased 19 percent for both multifamily and industrial property loans.

Among investor types, the dollar volume of loans originated during the third quarter increased for life insurance companies, which were up 4 percent, and for Fannie Mae and Freddie Mac, which were up 3 percent.

In contrast, originations for commercial mortgage-backed securities loans slid 53 percent, while commercial bank portfolio lending dropped 22 percent from a year earlier.

The buildup of commercial real estate loan portfolios on bank books also slowed, according to a CoStar analysis of third-quarter bank data released last week by the Federal Deposit Insurance Corp. Those portfolios had been growing at an annual rate of 4.5 percent through the second quarter. That rate slowed to an annualized rate of 3 percent in the third quarter.

The lending slowdown was particularly noticeable among some of the largest banks. Half of the 10 largest U.S. banks by commercial real estate loan holdings actually shrunk their portfolios, including the largest, Wells Fargo, which holds about $134 billion in commercial property loans. Wells Fargo's portfolio value shrunk by $2.7 billion from the previous quarter.

Other banks increased real estate lending, though they too signaled a change in strategy. Signature Bank, which holds the 10th-largest commercial real estate loan portfolio among U.S. banks with $27 billion, grew its portfolio at an annualized clip of 11.2 percent. Notably, however, even Signature signaled in its third-quarter earnings conference call that it intended to slow future real estate lending in favor of a shift to more floating rate lending, which Signature sees as giving it more flexibility as interest rates rise.

In addition to lower originations, part of the decline in commercial real estate mortgage loans at banks and commercial mortgage-backed securities lenders resulted from pay-downs on existing and acquired loans as borrowers take action in anticipation of further boosts to interest rates into 2019, according to Fitch Ratings. Fitch expects loan refinancing volume to slow through 2019 in reaction to additional interest rate increases.

During this shift in interest rates, several banks reported this past quarter that they were priced out of deals with loan terms that would never meet their underwriting guidelines.

"While [overall bank] results this quarter were positive, the extended period of low interest rates and an increasingly competitive lending environment have led some institutions to 'reach for yield,' " said Jelena McWilliams, chairwoman of the Federal Deposit Insurance Corp., noted in announcing third-quarter performance numbers for FDIC-insured banks just before the Thanksgiving break.

"Additionally, the competition to attract loan customers has been strong, and it will remain important for banks to maintain their underwriting discipline and credit standards. These factors have led to heightened exposure to interest-rate risk and credit risk," she said.
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