Feds See Increased CRE Lending Risk as Valuations Peak and Low Interest Rate Environment Comes to an End

 Multifamily, Owner-Occupied Property Loan Delinquencies Reverse Course, Start Moving Up
Originally posted by CoStar March 1, 2018

FDIC chairman Martin J. Gruenberg this week noted that the interest-rate environment and competitive lending conditions continue to pose challenges for many institutions. Credit: FDIC

New data and commentary from federal financial regulators are pointing to signs of increased risks in CRE lending.

Notably, the amount of delinquent multifamily and owner-occupied property loans on the books of U.S. banks increased in the fourth quarter of last year, according to statistics released this week by the Federal Deposit Insurance Corp. (FDIC).

And while the increases and total volumes are small, the uptick marks a change in the trend after multifamily delinquency levels hit the lowest mark ever recorded by the FDIC. The FDIC also reported a second quarterly increase in delinquencies for owner-occupied property loans, although by a low 0.4% to $6.74 billion.

The change in multifamily loan delinquency was more dramatic percentagewise, increasing 14.4% from the third quarter to the fourth quarter of 2017 to $1.08 billion. That change iin direction follows decreases of 4%, 8.1% and 9.8% over the first three quarters of 2017.

The FDIC data follows the Federal Reserve’s latest Monetary Policy Report that noted growing vulnerability in the commercial real estate sector.

“Valuation pressures continue to be elevated across a range of asset classes, including equities and commercial real estate,” the Fed noted in its report.

“In a sign of increasing valuation pressures in commercial real estate markets, net operating income relative to property values (referred to as capitalization rates) have been declining relative to Treasury yields of comparable maturity for multifamily and industrial properties. While these spreads narrowed further from already low levels, they are wider than in 2007,” the report noted.

FDIC chairman Martin J. Gruenberg this week said that the interest-rate environment and competitive lending conditions continue to pose challenges for many institutions.

“Some banks have responded by ‘reaching for yield’ through investing in higher-risk and longer-term assets,” Gruenberg said. “Going forward, the industry must manage interest-rate risk, liquidity risk, and credit risk carefully to continue to grow on a long-run, sustainable path. These challenges facing the industry will remain a focus of supervisory attention.”

Gruenberg earlier noted the challenge facing the FDIC is to preserve improvements in the capital and liquidity of U.S. banking institutions and to “continue the strong performance of banks during the post-crisis period and to position the banking system to weather the next, inevitable downturn.

“By many measures, stocks, bonds, and real estate are richly priced. Stock price-to-earnings ratios are at high levels, traditionally a cautionary sign to investors of
a potential market correction,” Gruenberg noted in the FDIC’s recent 2017 annual report. “Bond maturities have lengthened, making their values more sensitive to a change in interest rates. As measured by capitalization rates, prices for commercial real estate are at high levels relative to the revenues the properties generate, again suggesting greater vulnerability to a correction.”

Meanwhile, the total amount of commercial real estate loans held by U.S. banks and savings and loans continued to swell.

The total amount of CRE loans outstanding held by FDIC-insured institutions increased 1.2% to $2.13 trillion at year-end from the third quarter. That compares to an increase of 1% from mid-year to third quarter, according to the FDIC.

The $2.13 trillion year-end 2017 total CRE loans outstanding compares to $1.63 trillion at the last peak of the CRE markets at the end of June 2007.

Total loan amounts outstanding increased in every category of CRE lending broken out by the FDIC.

Meanwhile, real estate lending by banks increased in some areas while moderating in others. Construction and development loan totals jumped by $7.43 billion (2.2%) to $339.7 billion. Owner-occupied CRE loans increased $4.77 billion (0.9%) to $530.3 billion. The rate of increase in both of those categories exceeded the rates of at which those categories grew on average last year.

The rate of increase for the two other categories — other nonresidential and multifamily — were below the rates of at which those categories grew on average last year. Other nonresidential CRE increased $8.66 billion (1%) to $860.7 billion. And multifamily increased the least, $3.73 billion (0.9%) to $404.1 billion.

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