ROBERT CROWLEY
Sticking to fundamentals
Banks’ commercial real estate loans remain strong, having minimal effect on bank portfolios despite the deterioration of the current commercial real estate market, according to industry analysts.
In the Federal Deposit Insurance Corp.’s latest “FYI Update,” the FDIC examined how bank portfolios are still thriving in spite of problems in the commercial market.
Rich Brown, chief economist at the FDIC in Washington, D.C., said banks are doing surprisingly well considering the condition of the weak market, but in metropolitan areas like Boston, New York and San Francisco, banks need to keep a careful eye on industry trends.
“The commercial real estate market remains highly cyclical, especially in metropolitan areas. With the recession and problems in the technology sector, we’ve seen a collapse in demand [for office space] to a unprecedented degree,” said Brown. “There was a lot of demand when the market was tight and tenants were occupying space [and] assuming the business would grow. Now, those tenants are selling those spaces at wholesale … the fundamentals in office markets are not good.”
Brown said the hardest-hit cities were in the South and Southwest regions of the country, but said the Boston market also raises concern for industry analysts.
“There is a lot of increase in vacancy rates in Boston … a lot of these primary leases have [ended] and now the space is on the market and no one is paying for the space,” said Brown. “Specifically in Suffolk County, [where] the vacancy rate bottomed out at 2 percent in 2000, but is currently up to 10 percent.”
Brown said Essex and Middlesex counties, where the technology firms were clustered, showed a 2 percent vacancy rate in mid-2000 and a vacancy rate of 21.4 percent in the first quarter of 2003.
But some banks are not worried, and bankers say their portfolios are strong despite the drop in the market because of good decisions that were made long ago.
“From our standpoint, our portfolio is holding up quiet well,” said Robert Crowley, executive vice president of the commercial real estate division at Citizens Bank in Boston. “We tend to stick to the fundamentals of blocking and tackling – that is the focus of our strategy. We didn’t get caught up in dot-coms, and many of our relationships have spent the last couple of years on the sidelines and maintained liquidity waiting for opportunities to buy property that needed enhancements. That isn’t to say that some of our buildings haven’t seen a loss of tenants, but by sticking to our fundamentals, we require a certain level of guarantees.”
‘A Perennial Risk’
Analysts at the Risk Management Association, a Philadelphia-based association established to advance the use of sound risk principles in the financial services industry, said banks that make reliable loans, and not just any loan, will help their portfolios.
“New England is so densely built-up already … being focused on the office-warehouse-retail-multifamily properties are the main types of commercial property [investments for banks],” said Jim Nelson, director of credit risk of the RMA.
Nelson said the process of loans has evolved over the years, especially in an unsteady marketplace, and banks are making wiser decisions that have paid off in the long run.
“Every real estate transaction that a commercial bank does has to have an appraisal, so there are standards set out that the banks have to comply with. Banks are required to review that appraisal and concur if the appraisal is satisfactory,” explained Nelson. “Now developers have to put in real cash equity, whereas they didn’t necessarily have to do that 14 or 15 years ago. Developers have become more conservative because they have to put money in now and not rely on 100 percent from the banks, and banks know there is real equity in the development and go into a project with enough cash to service the loan.”
At Citizens, Crowley said the level of loans originated is as strong and it was last year, but the majority of commercial real estate deals have been for condominium and apartment complexes, and fewer them for office space.
“It’s all retail and condo complexes. We are seeing very little of any office deals, and that’s understandable when you look at the vacancy rate. Obviously I’m concerned about job growth,” said Crowley. “It’s a challenging time because everyone has goals and objectives and it’s very challenging to make those goals, but I don’t think we are going to make loans just to make our goals.”
And as industry analysts have confirmed, the real estate market is cyclical and banks are making wiser decisions with each cycle.
“We lost billions and billions to commercial real estate in banks in the last cycle, and now in this real estate cycle, it does not pose nearly the problems,” said Brown. “The amount of cash equity put down by developers and the amount of due diligence put out by lenders to make sure payments take place is better, and there is better data available that has allowed participants to see what is going on in the market.”
Brown said public awareness and understanding of the current marketplace has helped bank portfolios because members of the general public are making better decisions on their investments. Therefore, the future looks bright for the Bay State area, he said.
“Bankers still remember the lessons they learned from the 1980s … they don’t have the level of impaired loans on their balance sheets,” said Brown. “The performance of commercial real estate loans remains very strong and that is an indication that this cycle is not going to have nearly the same amount of problems as last time. Commercial real estate is a perennial risk and institutions are aware of the risk exposures. We are going to need to see job growth in order to restore demand for commercial real estate, but for now, Boston appears to be stable.”
Melanie Nayer may be reached at mnayer@thewarrengroup.com.
