In some ways, the outlook for commercial real estate loans is brightening.

Accommodation – the sector hardest hit by the coronavirus pandemic – is returning as people resume their travels. Retail is moving in the right direction as consumers start spending money in stores and restaurants. Even the office sector, CRE’s pandemic joker, is holding up for the moment.

But while fears of massive defaults have eased as the economy continues to improve, CRE lenders now have another worry: weak demand for loans.

Loan origins are still far from pre-pandemic levels and industry watchers say demand is expected to stay lukewarm at least until the end of this year, largely because companies have so much cash on hand. cash they don’t need to borrow. In addition, competition for quality CRE loans is intensifying, threatening to further reduce banks’ profit margins on loans.

“There is a lot of money ready to be deployed and there is a lot of competition on new loans,” said Matt Anderson, managing director of Trepp, a data and analytics company that tracks business trends. commercial real estate. “And that will probably eat away at the juicy margins that the banks could have hoped for.”

Across the industry, CRE’s total creations on commercial mortgages and construction and land loans are still well below pre-pandemic levels. Among large and mid-sized banks surveyed by Trepp, first-quarter mounts totaled $ 5.8 billion, down 51% from the previous year and 63% from the fourth quarter of 2019.

Trepp data shows first quarter loan origination down in all categories except commercial mortgages for multi-family properties and construction and land loans for office and retail sites. Retail.

Commercial mortgages for office, retail and housing lending volumes were only 33%, 42% and 10% of the 2019 quarterly averages for each of these categories, respectively, according to the data.

Trepp’s findings are based on loan level and performance data it collects quarterly from large and mid-sized commercial banks and inputs into an anonymized loan level benchmark called T-ALLR. Data accounts for almost 10% of all CRE loans at banks in the United States

Besides competition, record interest rates and the influx of deposits into the banking system pose the biggest threats to banks’ net interest margins. Banks have a lot of excess liquidity, but not enough loan application to use these deposits.

Overall, the industry’s net interest margin in the first quarter decreased to 2.56%, the lowest level on record in the Federal Deposit Insurance Corp. quarterly banking profile. The previous low was 2.68% in the third quarter of 2020, the FDIC said. In contrast, the industry average was 3.28% in the fourth quarter of 2019.

“The anemic loan production that we have seen over the past year has contributed to the weak net interest margins that we see in banks,” Anderson said. “Deposits are pouring in, but the banks, for the most part, haven’t turned around and made new loans. “

Factors affecting demand for CRE loans include higher construction costs, due to supply chain issues, and a shortage of skilled labor. With a shortage of materials and workers, some developers are postponing construction projects, experts say.

And for those loans that are made, banks face increased competition from non-banks, according to Mark Fawer, partner at law firm Greenspoon Marder. Private equity funds in particular, which were eager to lend to CRE, have been “very aggressive” with pricing lately, Fawer said.

Private equity “can offer loans at lower rates” and end up with “very high returns,” he said.

Some bankers are optimistic about the recovery in demand. In Evans Bancorp’s $ 2.1 billion assets in Williamsville, New York, the loan pipeline is heavily focused on CRE, said President and CEO David Nasca.

“We’re getting production and that will help offset any squeeze in margins,” he said. But, he added, other banks “which do not produce a lot and have a lot of deposits” could have problems of profitability.

The increased volume will help ease the pressure on margins, agreed Frank Schiraldi, analyst at Piper Sandler. But he doesn’t expect demand to pick up significantly until companies start spending all the money they’re sitting on.

“Ultimately we’re looking to get the origination volume back,” Schiraldi said. “But I think some of that hope will be pushed back to early 2022.”

Perhaps the best news for banks on the CRE front is that credit quality has held up better than expected, as evidenced by the fact that so many banks have released loan loss reserves that they had built up in the past. start of the pandemic. .

“We’re feeling pretty good in terms of credit losses on the CRE book,” Don McCree, head of commercial banking at Citizens Financial Group, with $ 187 billion in assets in Providence, Rhode Island.

“We took some big write-downs in the middle of last year on a few shopping center exhibitions, so it’s a bit behind us and we feel like we have a line of sight on any future loss of CRE,” McCree said during an industry. conference this month. “You can always get a surprise, but we think things are stabilizing pretty well.”

At PNC Financial Services Group in Pittsburgh, loan loss reserves were released in the first quarter, but the company with $ 560 billion in assets “actually continued to build reserves against the real estate industry,” the chairman said. -General Director William Demchak at a separate sectoral conference. also organized this month.

“There are always clients who are suffering,” said Demchak. “We’re well booked for that, but it’s going to play out over a long period, I think. “

For many banks, the office sector remains a big question mark. It remains to be seen how the pandemic will affect return-to-office plans and how much workspace employers will or will not need.

“There is concern that offices may be a bit supported by the fact that office leases tend to be long-term,” said Schiraldi. “In general, this is a type of property where it may take a little longer to see a fair reflection of what the values ​​are.”

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