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CRE Exposure Hinders Community Bank Lending - But Not Big Banks?

July 1, 2011

As investors in small-cap properties know all too well these days, a lot of community bankers around the country that had been active in CRE lending before the Great Recession continue struggling mightily with exposure to distress-plagued (and mostly small-balance-heavy) commercial mortgage portfolios.

But an analysis by Trepp LLC performed for SmallBalance.com provides some surprising insights into contrasts in CRE portfolio performance of community banks relative to their larger brethren. The research helps explain the irony that while many community banks are still struggling to dispose of non-performing small-balance mortgages, their portfolios are generally in better shape than those of larger banks.

Among the key points Trepp managing director Matthew Anderson gleans from the data is that large banks facing heavy exposure to CRE have taken great pains to divest and work out distressed mortgages - and, at the same time, to improve soundness by raising new capital.

Meanwhile community banks with equally daunting CRE exposure levels don’t boast the same level of access to new capital. In addition, the smaller institutions have not been under quite as intense regulatory pressure to improve portfolio performance.

The upshot is that while overall CRE portfolios of community banks are clearly performing better than their big-bank counterparts, the cohort of large banks with heavy CRE concentrations are now performing even better than community banks. Yet in sharp contrast, the group of community banks also facing heavy CRE exposure are performing worse than the large-bank sector overall.

Some elaboration will help put this all in perspective. Trepp’s analysis of its own and Federal Financial Institutions Examination Council data clearly indicates banks with $5 billion or less in total assets actually experienced lower average delinquency rates than banks with assets of $5 billion or more through the first quarter (see the first graph).

In the aggregate, loan delinquencies for all types of CRE averaged 6.9% for the 6,775 smaller banks as of first quarter compared with 8.5% for the 145 larger institutions.

Loan performance among the individual CRE loan types followed suit. For instance, the delinquency rate for non-residential land and construction loans averaged 16.8 percent of the outstanding principal balance for smaller banks - compared to 18.4 for the larger banks. Likewise, with permanent commercial mortgages secured by non-owner-occupied properties, the delinquency rate for community banks was 4.9 percent, compared to 6.6 for larger banks.

The outperformance of smaller banks extends to apartment and owner-occupied properties as well: 4.5 percent in both categories for community banks, compared to 4.9 and 5.2, respectively, for larger banks. The contrast in fact was far more dramatic with single-family construction loans: a 13.1 percent delinquency rate for community banks - barely half the 26.1 percent for larger banks.

These figures underscore the implicit advantage that some prudent community lenders may sustain in underwriting local credits and borrowers.

So the question remains: How is it that selected large banks that were very active CRE lenders pre-recession are once again funding these mortgages - while so many community banks remain focused on managing or disposing of soured CRE assets?

The answer lies deeper in the research. It also relates to different regulatory efforts - and responses thereto - directed at big banks compared to community banks, Anderson adds.

Looking beyond just the context of larger versus smaller banks - and factoring in the degree of "CRE concentration" as defined by regulatory guidance handed down pre-recession in 2006 - it quickly becomes clear that the portfolios of large banks with heavy CRE concentrations are now in better shape than large institutions with less exposure.

Furthermore, the larger banks with heavy CRE concentrations are likewise performing materially better than the community banking sector. As of first quarter, the overall CRE portfolio delinquency rate among large banks with high CRE concentrations was 5.3 percent. For the smaller banks with high exposures, the delinquency rate was 9.7 percent (see the second graph). Nearly all of the individual commercial property-secured loan categories analyzed through the Trepp and FFIEC data mirrored this relationship - the only arguable exception being land and construction loans.

However, this inverse relationship between (higher) CRE exposure and (lower) delinquencies recorded by the larger banks doesn’t extend to community banks. Smaller banks with greater CRE exposure have higher aggregate CRE delinquency rates (9.7 percent) than less-concentrated small lenders (5.5 percent). The differentials are pronounced for several categories: apartment mortgage delinquencies (3.6 percent vs. 6.2), other income-property permanent mortgages (4.1 percent vs. 6.5), and owner-occupied property loans (4.1 percent vs. 5.9).

Moreover, among the community banks with heavy CRE concentrations the delinquency rate for land loans and non-residential construction credits (21.0 percent) is also substantially higher than for those smaller banks with lesser exposure levels (13.5). The corresponding rates for the large banks are 16.8 for high-exposure institutions and 18.5 for lesser-exposed.

Again, Anderson suggests the striking difference in portfolio performance reflects both greater regulator-driven efforts by large banks to clean up their balance sheets, along with the big institutions’ superior ability to raise new capital when necessary.

"I think the explanation for this is that the larger banks have both been able to raise more capital (through securities sales), and have been under great regulatory pressure to improve performance" by disposing of distressed CRE assets, as Anderson puts it. "At the same time, the community banks have not had as much access to capital, and have therefore not been as able to take losses and dispose of problem CRE loans."

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