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Commercial and industrial lending is rising at some community banks, but it's unclear how much of the gain reflects rebalancing and how much suggests a deepening recovery.
January 27
A source of industry ruin became a surprisingly lucrative growth area for some big banks last quarter: commercial real estate.
Wells Fargo & Co., U.S. Bancorp, M&T Bank Corp. and others extended more business property loans during the last three months of the year, taking advantage of a modest improvement in a once-toxic field that smaller rivals have all but abandoned.
Wells Fargo — in increasing its CRE book for the first time in at least a year, by about $100 million, or 1% — made a $6 million mortgage to the owner of a shopping strip outside of Chicago that used to do business with the now-defunct Bear Stearns.
U.S. Bancorp extended $4 million in real estate-secured credit to a Chicago metal-bar maker that had taken a $5 million mortgage from rival Harris NA five years ago. Its CRE lending was up 3%.
And M&T extended new credit to manufacturers and health care businesses from Philadelphia to Washington on the way to booking $600 million, or 3%, more business property loans last quarter, its first quarter-over-quarter growth in at least a year, too.
Other big banks like Regions Financial Corp. and First Horizon National Corp. made more business mortgages in parts of Texas and Tennessee even as CRE loans ran off the books elsewhere.
"It's really just a reflection of the economy," said Rene Jones, the chief financial officer of M&T, of Buffalo N.Y. "It's across the board — what you see is a lot of activity on the commercial front."
The fact big banks like M&T are happy to take advantage of that activity is a reminder that commercial real estate — a catchall term used to describe everything from a mortgage on a supermarket to a home builder's construction loan — can still be lucrative, experts say. Most of the 157 banks that failed in 2010 went under because they had made too many poorly underwritten business property loans in boom times that went bust.
The growth also illustrates the competitive edge big banks have over community lenders as the economy recovers slowly, observers say. Superlarge banks now have the opportunity to dominate a lending market that became the favorite asset class of smaller institutions last decade.
"The smaller companies are the ones being left out in the cold," said Chris McDonnell, a vice president with the consultancy Greenwich Associates in Connecticut.
It is too soon to tell whether large banks are going to make a major play of CRE: M&T, Wells Fargo and Regions all framed their CRE growth as simply helping new and old customers build their businesses, rather than some concerted market-share grab.
"We are still making commercial real estate loans. The demand for that product is fairly limited and is much better underwritten and much better priced," O.B. Grayson Hall, the CEO of Regions, in Birmingham, Ala., told analysts on Tuesday. "But it's not sufficient today to sustain the level of commercial real estate loans that we have."
Though Regions' CRE secured by properties that their business owners operate grew by $144 million, or 1% last quarter, Hall said its total CRE balances could eventually "drift below" $14 billion. It had about $16 billion at yearend.
CRE is attractive to banks for a number of reasons. Though commercial property values and corporate profits are still depressed, they are getting better in certain parts of the country like Chicago, Washington and New York. Commercial property prices rose for the third straight month in November, by 0.6%, and were up about 2.8% from a year earlier, Moody's Investors Service reported on Monday. The market seems to have finally bottomed.
Office building owners, manufacturers, retail strip developers and apartment landlords that survived the recession will eventually have to fix up their properties and restock inventory.
Large banks are sitting on massive amounts of cheap funding that they can earn more money on by lending out as property loans than they can by investing in low-risk securities, like three-year treasury notes. U.S. Bancorp's CRE loans, for instance, yielded 4.51% last quarter. Its investment securities: 3.51%.
Terry McEvoy, a managing director with Oppenheimer & Co., said the incentives to lend are straightforward.
"Why not? Asset values have been written down. You're kind of controlling the process. You are more than likely going to get paid for the risk," he said.
Banks are also getting much more favorable terms than they were before the downturn, McEvoy said, like huge equity commitments from borrowers and guarantees on property owners' personal assets. The downturn has also eliminated much of the competition for these types of loans, too.
Though the broader CRE market — particularly in home building — "will remain extremely stressed" for the next year and a half, "there is some demand out there" for property loans from apartment owners and medical office product makers, P.W. Parker, U.S. Bancorp's chief credit officer, told analysts on Jan. 19.
But taking its CRE business national in the past two years paid off for U.S. Bancorp in the fourth quarter: Average commercial mortgage balances rose nearly 3%, to $742 million, while it collected $393 million in CRE loan interest, slightly more than it did in the previous quarter and 7% more than it did a year earlier.
Commercial real estate remains a huge problem for banks and the real estate markets overall. There are concerns it may cause hundreds more failures, especially as a huge wave of property loans banks made during the credit boom begin maturing in 2012. Ongoing problems with outstanding construction loans in depressed markets like Arizona and Delaware were the key reasons that Marshall & Ilsley Corp. of Milwaukee and Wilmington Trust Corp. in Delaware were forced to sell themselves late last year.
The banking industry's outstanding CRE balances — nearly $1.5 trillion as of December, according to regulatory data — has been contracting for two years and will continue to do so as banks charge off and write down the values of troubled loans, particularly those tied to housing.
The banks that are wading back into CRE say they're being careful to steer clear of home builder and property development loans that are causing small institutions so much pain.
"A lot of what we call commercial real estate is actually loans we make to a business customer on their property," Howard Atkins, Wells' chief financial officer, said in an interview on Jan. 19. "So it is owner-occupied, which is a much higher calibre commercial mortgage than a typical construction project would be."
Wells has also known most of its CRE borrowers for years, he said, so it is better positioned to properly manage the risk and negotiate favorable terms.
