Commercial real estate lending has officially made a comeback at SunTrust Banks. The Atlanta-based regional banking company posted a 20% annual increase last year in average performing loans backed by CRE, with about half the rise coming in the fourth quarter.
It has been a long time coming—six years since the onset of the recession and with it a sharp downturn in the industrial, hospitality, office, multifamily, and retail commercial property markets.
"Commercial real estate typically lags the start of the recession going down and it lags the recovery from the recession coming out," says Walter Mercer, SunTrust's head of CRE lending.
Over the last year clear signs of a recovery have been appearing around the country: property prices are up, overall mortgage debt is rising, and investors are injecting new equity into property deals. Just as importantly, the industry has continued to slough off loans that turned bad in the wake of the financial crisis.
At their peak, in early 2010, nonperforming CRE loans put $154 billion of pressure on the balance sheets of U.S. banks, according to an analysis of Federal Deposit Insurance Corp. data by Trepp, a New York-based firm that tracks the CRE market.
"There's a decent-sized drop there," says Matthew Anderson, managing director in Trepp's Oakland, Calif., office. "They have shed $100 billion of problem assets."
There's still work to do, however, especially for smaller banks and those competing in smaller markets.
National banks and large regionals have had an easier time finding investors to buy up their troubled real estate exposure, because the properties involved tend to be more attractive. This is partly due to the larger scale of the projects financed by bigger banks, and partly due to pricing that is at or above the 2007 peak for many major markets.
According to Moody's/RCA Commercial Property Price Indices, an all-property composite index, prices nationally in November 2013 remained about 10% off the peak in November 2007, representing a recovery of three-fourths of the peak-to-trough decline in values. But the averages are skewed by the major markets. Outside those markets, prices have recovered only slightly more than half their decline in values.
"The challenge now is there are a lot of small, lower quality assets out there," says Paul Brenneke, founder and CEO of Guardian, an Atlanta-based real estate investment banking firm that has found buyers for troubled loans and in some cases helped banks rebuild their capital base.
"You go outside the top 100 or 200 banks, then you start to get into the sub-$5 billion or $2.5 billion smaller banks. They still have bad assets they've been nursing along for years," he says.
The worst excesses occurred, of course, in construction and development loans. Gerard Cassidy, bank analyst at RBC Capital Markets, Portland, Maine, compares the debacle to the drubbing banks took on CRE in 1990, when losses followed a glut of new-construction office buildings. Only this time around, the worst excesses occurred in single-family developments and condominium projects.
MBank of Gresham, Ore., is one community bank that struggled against the odds after land values collapsed. The bank had $230 million in loans when the housing bubble burst, including $80 million in land development loans for single-home construction.
"We experienced extreme pain as subdivision after subdivision dropped off and developers walked away from loans and handed us deeds," says Jef Baker, MBank's president and CEO.
Almost overnight, a parcel of land once worth $1 million dollars, against which the bank might have lent $700,000, was suddenly worth just $100,000 to $200,000, he recalls.
Baker, at the time the bank's chief financial officer, concluded in 2010 that MBank had only a 5% chance of survival, and he urged his fellow executives and the board to move more aggressively to sell off the properties classified as other real estate owned. At first, the others were reluctant. "We just couldn't believe how much [of a] loss we were going to have to take and we held onto them much longer than we had to," says Baker.
After he was made president in October 2011, Baker called on Guardian to help locate buyers from around the country. The vigorous effort that followed to dispose of troubled assets allowed MBank to reduce its overall loan portfolio from $230 million to $125 million, even as it has made new CRE loans, Baker says. MBank was sometimes willing to extend loans to the new owners of properties, when there were new equity infusions, and in the process turned some nonperforming assets into performing ones.
Selling off bad assets helped the $173 million-asset MBank fortify its battered capital ratios, but more capital was needed. Last year, Guardian helped the bank raise $2.5 million in a private placement. The bank is operating under a regulatory consent order, but Baker hopes to be able to convince the FDIC to lift that soon.