Bankers rattled as nonbanks' CRE lending spikes

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Bankers are growing increasingly concerned that nonbanks will cause headaches in commercial real estate lending.

Though CRE loans are performing relatively well, bankers worry that heightened competition could crimp profit and chip away at credit standards. Overall, CRE loans at banks increased by 4% in the first quarter from a year earlier, to $1.5 trillion, according to data from the Federal Deposit Insurance Corp.

The $26.5 billion-asset Investors Bancorp has closed $130 million in real estate deals in recent weeks, but Joseph Orefice, the Short Hills, N.J., company's head of CRE lending, said it is getting harder to book more loans. He pointed to more activity by nonbanks.

"The number and type of lenders continue to grow, and each day we’re facing more competition,” Orefice said, noting competition is coming from Fannie Mae and Freddie Mac for multifamily deals and insurers and conduit lenders for other credits. Big banks have gotten more aggressive, too.

“There’s a strong appetite for assets,” Orefice explained. “Real estate lending is a relatively safe haven. If you look at the places you can put your money, CRE is attractive.

Other bankers are also talking more about intense competition.

“There’s no doubt about it, it’s super-competitive in this space,” said Andrew Lucca, western regional executive in KeyCorp’s income property group.

“Just different institutions that we never really saw before entering the space,” Lucca added. “The amount of capital that’s flooding in. That's definitely different."

The $141.5 billion-asset KeyCorp increased its CRE assets at a 5% annualized clip in the first quarter — but the going is getting tougher.

“The market is awash with capital,” Lucca said. “Transaction volume isn't keeping up with the amount of capital that’s in the market. All these nontraditional lenders have [come in]. In addition, you’ve got all the banks that are competing ferociously to retain and grow loan balances.”

Indeed, alternative lenders have been capturing CRE market share from banks for the past two years, said Ely Razin, the chief executive of CrediFi, a CRE data provider. Debt funds, including private-equity and specialty lenders, mortgage real estate investment trusts and CRE owner-affiliated funds constitute the bulk of the new players.

CrediFi lists CBRE Group, Arbor Realty Trust and Greystone & Co. as the three nonbanks with the most multifamily financing in 2018. Those companies, along with Berkadia and Walker & Dunlop, each originated more than 500 multifamily loans last year.

“Unquestionably, nonbanks have less regulation and more freedom to source and structure deals, and manage risk,” Razin said. “This can matter a lot in CRE lending, which is characterized by large, chunky loan amounts, complicated, fact-specific situations, and long loan tenures. As a result, loan pricing, risk structuring and other terms can really matter.”

That enhanced flexibility to structure loans is what worries Lucca.

“We're seeing other [lenders] kind of pushing the envelope in terms of structure, allowing mezzanine debt or preferred equity that’s really mezzanine debt,” he said. “We’ll do it on occasion, based on the relationship and how much cash equity the borrower has in the transaction. However, it’s important to note KeyBank continues to maintain a moderate risk profile.”

At this point in the cycle, the risk lies in pushing leverage up and settling for less equity in deals, which serve as indicators that a cycle is set to turn, industry observers said.

“We compete pretty aggressively in California and I can tell you we’re absolutely seeing less and less structure from certain competitors,” Lucca said. “You can't continuously structure deals like that, because you'll have a blowback at some stage when some black swan event takes place.”

Edward Czajka, chief financial officer at the $4.3 billion-asset Preferred Bank in Los Angeles, said his company has managed to avoid much of the CRE competitive pressure by focusing on shorter-duration loans.

“We typically do not go out 10 years on CRE,” Czajka said. “We keep it five years and in.”

“We're fortunate in that we stand in a little bit different spot relative to what goes on with a lot of the larger [bank] CRE lenders and the nonbanks,” Czajka added. "Typically, they're more focused on permanent CRE financing.”

Still, Czajka said he is seeing some concerning trends.

“Yes, 10- and 15-year CRE loans are getting more competitive, not only by rate," he said. "One thing we’re seeing that we haven’t seen in a while is interest-only terms. That's one component that makes it very difficult for [banks] to compete. It is just not something we like to do from a risk standpoint.”

In a survey conducted in April by Promontory Interfinancial Network, banks identified CRE as their biggest credit-risk red flag.

To date, banks' CRE portfolios continue to perform well in terms of credit qulity. Through March 31, the noncurrent rate for CRE loans industrywide was 0.59% according to the FDIC. That's up slightly from 0.57% at Dec. 31, but down from 0.61% a year earlier.

"We’ve held to our credit standards [and] the larger money-center and regional banks I absolutely believe have been disciplined versus the last downturn we had," Lucca said.

While nonbanks may be able to offer more flexible terms, banks’ relationship-lending model remains attractive to many CRE lenders, Orefice said.

“There’s a certain clientele that looks for" stability, Orefice said. “They know the value of a balance-sheet lender. They want relationships.”

Even so, the climate remains challenging.

“A lot of our assets have been on our books five, six, seven years," making refinancing attractive, Orefice said. “We're being very aggressive" combating that. "We certainly don’t want people to leave.”

Key also focuses on building borrower relationships.

“We try to do multiple things with our borrowers, not just extend credit to them,” Lucca said. He stresses the quality of the loan servicing banks do to help offset concerns about rates and loan structures.

“What happens after the loan is booked and there are issues?” Lucca said.

“A bank that you have a relationship with is going to work with you to resolve issues that inevitably take place," Lucca added. "If you have an issue on a transitional asset, good luck if you have to deal with a special servicer versus a portfolio lender like a bank.”

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