With all the handwringing over Commercial Real Estate (CRE) loans and the impact to banks, in particular the small to mid-size category, I figured it was time to put my thoughts together. It’s one thing when business rags carry headlines like:
Commercial real estate foreclosures jumped 117% in March as trouble looms (Fox Business)
Don’t be too quick to blame Fox. The real culprit are statistics, or as described in Wikipedia, “Lies, damned lies, and statistics” is a phrase describing the persuasive power of statistics to bolster weak arguments, “one of the best, and best-known” critiques of applied statistics. It is also sometimes colloquially used to doubt statistics used to prove an opponent’s point.”
Now, I like statistics but grant they are rife for misuse. Unfortunately, CRE has a definitional problem. As presented by Commercial Edge, there are eight categories of CRE – each with a distinct subset. “While office, industrial, retail and multifamily are considered the main categories of CRE properties, the commercial industry also encompasses hospitality and mixed-use assets, as well as land and special-purpose real estate. Each property group features its own set of distinct characteristics.”
The issue arises when the CRE moniker is applied. What groupings or subsets are contained in any given analysis. This isn’t reserved just for the shock value of any given headline, the source data – while numerically accurate – is problematic. Reviewing the chart below of three of my banks provides an illustration of this.
The consumer loan category can be segmented fairly easily, but the commercial side isn’t quite as straightforward. In fact, City Holding (CHCO) notes they lump retail, office, warehouse, storage, religious, healthcare and entertainment together. I assume Wesbanco’s (WSBC) oil and gas loans are categorized industrial while BancFirst (BANF) has theirs separate. BANF is the only one segmenting by loan length – at least externally. Obviously, without a common institutional definition it’s little wonder that one media outlet can interpret and report the same data differently than another. And you thought it was a political slant …
The reality is there is a CRE day of reckoning coming sometime over the next few years. The magnitude and degree are unknown as each institution has a level of autonomy on how this plays out. Rather than an unfiltered list being promoted as the answer, as commentor nckadams points out,
“To assess the risk in a CRE portfolio properly, one must disaggregate it across several variables, such as:
1. Property type (e.g. multi-family; local strip malls; warehouses; offices; multi-purpose; hotels/motels, etc.)
2. Loan size (risk mitigation via diversification)
3. Loan type (e.g. land, infrastructure development, construction, stabilized occupancy, etc.)
4. Interest rate sensitivity (floating rate vs. fixed rate, type and extent of interest rate hedging)
5. Occupancy rate and lease roll-off schedule
6. Debt service coverage and LTV
The point is that one can not make a judgement on portfolio quality simply by knowing the aggregate amount of CRE loans.”
It is entirely possible that this is not all doom and gloom either. Case in point in Guaranty Bancshares (GNTY) earnings call Q&A on a property they foreclosed in Austin.
The part that we own now is retail on the first floor then there’s condos above it, and there’s a large parking garage that we own. The property — this was part of a larger company that had multiple projects, most of them under construction, had problems internally and externally apparently. Our property was stabilized, leased up. They actually were making the payments through year-end. It just, ultimately, they started liquidating the company. The trustees did.
We’re yielding — the loan was at 4%. We’re actually yielding around 4.5% now on a net NOI on the property. We have two vacancies. We have a lease that’s about to execute. We did hire a really good property manager there in Austin, it’s managing it for us. We do have this in a real estate subsidiary of our bank that they’re holding us in. We do have two vacancies, one lease that they should have signed any day now that will bring the yield up to about 5%, a little over 5%, maybe 6%. And then the second location — the second space, we’re in discussions with one group and going back and forth on LOI. If we get that closed and that’ll be — it’ll be 100% occupied. It’ll be yielding 6.5% — between 6.5%, 7%. And our plan is to market the property and sell it.
The real question then becomes is this a one-off, a reflection of how the issue will play out or something in between. Only time will tell. Have a good week!
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