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NewsCalifornia Real Estate JournalNovember 3, 2008 Bank Lending to Remain More Costly in 2009 By MANDY Banks that provided competitive interest rates and manageable loan-to-value ratios in early 2007 have increased their pricing and reduced their lending this year - if they are still in business. From the multibillion-dollar variety to small local institutions, banks are hurting. And while lending to commercial real estate already was tight this year because of rising losses tied to residential mortgages, loan pricing and the amount banks are willing to lend likely are to remain squeezed after the current financial market turmoil eases. Banks cannot afford to lend much money until they resolve problems in their portfolios and increase their capital reserves, according to "Emerging Trends in Real Estate 2009," released by the Urban Land Institute and PriceWaterhouseCoopers LLP last month. Emerging Trends notes that regional banks could fail due to troubled homebuilder loans and any deterioration in commercial real estate markets could add to the damage on their balance sheets. Banks have a chance to stabilize in 2009, but lending for commercial real estate is expected to remain constrained. Bob Bach, senior vice president of research for Grubb & Ellis Co., said commercial real estate began seeing the impact of fewer banks lending to the industry in August 2007. "Investment activity has been way down ever since then," Bach said. "Prices are on the way down and capitalization rates are on the way up." Into next year, he said credit will be tight and difficult to get and that will keep investment transaction volume on the low side. Less transaction volume and rising vacancies will contribute to reduced pricing. "We will see an increase in delinquency rates and properties going back to the banks," Bach said. "That will have an impact on pricing as well, like in residential, but not to the same extent." Losses from real estate loans have forced a growing number of banks into failure and acquisitions by other banks. Some of the largest lenders in the multifamily sector as ranked by the Mortgage Bankers Association of America soon will disappear. MBA reported that the top five multifamily lenders in 2007 by dollar volume were Wachovia Corp., Washington Mutual, Deutsche Bank Commercial Real Estate, Capmark Financial Group Inc. and Wells Fargo & Co. That list will be forced to change as JPMorgan Chase is in the process of acquiring Washington Mutual, and Wells Fargo is set to acquire Wachovia, reducing the number of players and sources of multifamily finance. Of the 48,577 multifamily loans on properties with five or more units totaling $147.7 billion in 2007, Wachovia closed 1,673 multifamily loans totaling $20.6 billion in 2007, followed by Washington Mutual with 7,632 loans totaling $10.7 billion and Deutsche Bank with 401 loan totaling $8.1 billion. Credit Crunch Last week the Treasury Department started to deploy the first funds from the $700 billion financial rescue package approved by Congress last month. Deals were signed with nine major banks on Oct. 26 to purchase $125 billion in stock to bolster the banks' balance sheets so they can resume lending. Another $125 billion in bank stock purchases is expected to be approved by the end of this year. This effort along with plans to purchase $100 billion in bad assets from banks in coming months along with a steady lowering of interest rates represents a historic effort to restore confidence in the financial markets and normalize the lending markets. While banks have lowered the interest rates they charge when lending to each other, the slight easing in the credit markets does not seem to have trickled down to commercial real estate lending. Banks still are reporting billions of dollars in losses and holding on to the cash that remains on their balance sheets. For every dollar a bank loses, it loses $17 in lending capacity, said Gary E. Mozer, managing director and principal at George Smith Partners in "In the bank landscape, a lot of them used up their [lending] capacity earlier this year," Mozer said. "Banks are typically a short-term lender, but nobody's paying back loans." With less money coming in and losses growing, banks are providing fewer loans, funding 15 percent to 20 percent less of the property value and charging higher interest rates. Banks also want to upgrade their customer base by lending only in primary markets on institutional-quality real estate with high-credit quality borrowers. That doesn't mean, however, that it's easy for the highest-quality sponsors to get money from banks. Bob Eller, partner in the "The clients I represent are the real high-end developers; a lot of them are privately owned but they have as their partners major pension funds and other kinds of funds that are either privately owned or on the stock exchange," Eller said. "They're highly well capitalized and strong. Does that make a difference? No." Eller said the list of banks that might be willing to enter into a syndicate to fund a construction loan in a major metropolitan area or highly desirable suburb might have included 100 lenders even three months ago and there are now no more than 10 banks willing and able to commit funds for that type of loan. He said many banks have gotten out of the business on a short-term basis, because they're worried about the quality of real estate, the valuations and the likelihood of the other lenders in a syndicate staying in for the full term of a construction loan. "Banks are not lending 80 or 90 percent of construction cost; they're now lending 70 or 60 percent," Eller said. "Developers are having to put in more equity or get an equity partner." National, Regional, Local Eric Von Berg, principal at Newmark Realty Capital Inc. in More than half of the capital structure for a big bank is short-term commercial paper versus deposits, with a two-to-one ratio for European banks. With the market for commercial paper shut down, those big banks have no new cash, so they're using deposits to pay back commercial paper and their own debt, Von Berg said. As developers fail to find take-out lenders for their construction and bridge loans, banks are taking over that debt, which also limits their ability and willingness to lend. Additionally, capital is being used up at big banks by corporate and government borrowers who are drawing down previously extended lines of credit before banks can reclaim those funds to shore up their balance sheets. "We're finding that [local and regional banks] are not wanting to lend near their credit limits," Von Berg said. "If they can lend up to $16 million on a transaction, they're willing to do only half." Local and regional banks were a big source of commercial real estate debt earlier in the year, before the credit market began to shut down in September. Von Berg said the Federal Deposit Insurance Corp.'s decision to increase deposit insurance for bank accounts will help restore confidence to bank customers and reduce the chances of account holders taking their cash out of smaller banks. "It's very hard to get things done and you're often using whatever pressure you can - playing up the existing relationship you have or threatening to pull it or the borrower's relationship - to do whatever deal you can," Von Berg said. As local and regional banks go out and raise money, it will likely be at very expensive interest rates, he said, and smaller institutions will pass on their costs in the form of higher interest rates for commercial real estate investors and developers. In the future, Von Berg said there may be certain lending classes that banks choose not to go into again. "Hopefully we'll never see subprime again, but there may be other asset classes they choose not to lend in and the private market will have to take care of it," he said. San Diego Trust Bank, which has two branch offices in downtown Michael Perry, chairman, president and chief executive officer of San Diego Trust, said his five-year-old bank still provides mini-permanent loans and construction financing. "We have not been slow to respond to changes in the market," Perry said. "We've had some borrowers that obviously have felt the constraints of the contraction. Because of the way we have underwritten the deals, there is sufficient equity for them to refinance or restructure with another institution or sufficient funds to continue paying on our debt." San Diego Trust reported net earnings of $111,000 in the third quarter and $411,000 for the first nine months of the year. The local bank had $106.9 million in total assets as of Sept. 30, up 7.9 percent from $99 million a year earlier. Loans totaled $63.8 million in the third quarter, down from $69.8 million as of Sept. 30, 2007. The bank has never had any loan losses. "Because of our shift in focus three years ago, we focused on continuing to increase our deposit base, because we thought there was a liquidity crunch that might materialize," Perry said. "We have excess liquidity so we're able to lend to qualified borrowers when many institutions don't have the ability to do so." Strong Will Survive Perry said there will be a cleansing in the banking industry, with large national banks failing because of their losses on mortgage-backed securities, collateralized debt obligations and other capital market instruments. He said some community banks will run into trouble because of their construction loan portfolios. "We will see more increase in mergers and acquisitions on both sides of the spectrum," Perry predicted. "Banks that can adapt and have the capital and liquidity and earnings will survive." Just surviving won't be easy in the current economic climate. Culver City-based Alliance Bancshares of California, the holding company for Alliance Bank, reported a $15.3 million net loss in its second quarter compared to a $2.2 million profit in second-quarter 2007. In October, Within the federal government's $700 billion bailout plan for the financial markets, $250 billion will be invested in shares of several banks. Half of those funds, $125 billion, will be invested in the nine largest banks. Citigroup, which reported a $2.8 billion loss in the third quarter, has indicated plans to acquire other financial institutions during the current financial market turmoil. Its attempts to acquire Wachovia and Washington Mutual failed, but the $25 billion Citigroup will receive from the federal government could be used for that purpose. In a report on government efforts around the world to shore up financial institutions, Standard & Poor's Ratings Services said capital infusions and other actions by government agencies will make banks look stronger in the eyes of investors in the short term by improving liquidity and augmenting capital holdings. Those efforts are not expected to improve fundamental earnings and asset quality over the long term, however. Banks are working to increase their capital without government assistance. Minneapolis-based U.S. Bancorp reported net income of $576 million, down from $950 million in the second quarter and $1.1 billion in third-quarter 2007. The parent company of U.S. Bank attributed its growth in part to new deposit business as consumers sought out banks with a strong capital base in recent months. The decline in net income was attributed to higher credit costs and increasing numbers of mortgage defaults. U.S. Bank's non-performing assets increased 31.5 percent between the second and third quarters to $1.5 billion, which was less than 1 percent of its outstanding loans and other real estate assets. "Throughout the quarter, our business lines remained focused on revenue growth initiatives, while continuing to prudently manage risk," said U.S. Bancorp Chairman, President and Chief Executive Officer Richard K. Davis. As banks get a better handle on the risk in their real estate lending, borrowers can expect to see the cost of debt rise at least to levels that were last seen before real estate gained favor among a wider swath of investors and lenders at the beginning of this decade. "I think pricing is going to return to more normalized levels," Perry said. "People are going to bet back to fundamentals and realize they have to price the risk they're taking, so pricing will go up. And there will be fewer lenders, so only the most viable borrowers with the best strength will get loans." - E-mail Mandy_Jackson@DailyJournal.com |
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