Regulators Warn Against Lax CRE Underwriting Standards
Commercial Real Estate lending continues to explode. Through the third quarter of 2015, CRE loans outstanding totaled over $1.8 trillion. Over the last 8 years or so, CRE underwriting standards have eased somewhat. The Federal Reserve, FDIC and Comptroller of the Currency issued a Joint Statement at the end of 2015 warning about this problem.
“The agencies have observed substantial growth in many CRE asset and lending markets and increased competitive pressures are contributing significantly to historically low capitalization rates and rising property values. At the same time, other indicators of CRE market conditions…do not currently indicate weaknesses in the quality of CRE portfolios…. [T]he agencies have also observed certain risk management practices at some institutions cause concern, including a greater number of underwriting policy exceptions and insufficient monitoring of market conditions to assess the risks associated with these conditions.”
The statement directs financial institutions to reinforce prudent risk management practices and to maintain discipline in CRE lending. Examiners will be closely watching lending practices in the future.
Lenders have not yet reacted to the statement nor announced plans to change underwriting standards or practices or whether they will scale back CRE lending as a direct result of the statement. But, the question becomes ‘do the agencies see the current CRE conditions as similar to the conditions that lead to the housing bubble and crash of the late 2000’s?’ There, housing values continued to increase, to the point that they were artificially high. Good underwriting practices were totally ignored and, the combination of the 2 in addition to teaser loans, led to mass loan defaults. Yes, I am purposefully leaving out the CMBS aspect of the bubble, but, from the bank/consumer side, the agencies’ statement of concerns sounds very similar.
For now, we need to take the statement as a warning – not just to be careful in our CRE lending and borrowing practices. But that the good times in commercial real estate will not last forever. We know that they never do. Developers, investors and lenders can hedge against another devastating crash by not growing complacent and succumbing to short cuts as everyone did with the housing crisis. With good due diligence and smart practice, the next “crash” will only serve as a “market correction”.