Agencies Warn on CRE for Good Reason
Late last month, the federal banking agencies issued a joint statement raising concerns about growth in CRE, similar to the largely unheeded warnings issues in 2006, which the banking industry decide to fight instead.
The agencies have observed that many CRE asset and lending markets are experiencing substantial growth, and that increased competitive pressures are contributing significantly to historically low capitalization rates and rising property values.2 At the same time, other indicators of CRE market conditions (such as vacancy and absorption rates) and portfolio asset quality indicators (such as non-performing loan and charge-off rates) do not currently indicate weaknesses in the quality of CRE portfolios. Influenced in part by the continuing strong demand for such credit and the reassuring trends in asset-quality metrics, many institutions’ CRE concentration levels have been rising.
The agencies’ examination and industry outreach activities have revealed an easing of CRE underwriting standards, including less-restrictive loan covenants, extended maturities, longer interest-only payment periods, and limited guarantor requirements. The agencies also have 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.
When the economy limps around a below-trend growth for several years while asset prices skyrocket, it’s not hard to predict trouble ahead. It’s noteworthy that all major commercial real estate classes, including suburban office (included here because it is the weakest performing asset class) either are at or well-exceed prior peak levels. Apartment prices have risen the most and are 34% higher than 2007 levels. Check out this link for all of the indices.
Additionally, bankers are often the last to think that global or national trends affect their institution and their customers, acting as if their trade area occupies a non-correlated alternative reality.