The Glass Is ‘At Least Half Full’: Q3 CRE Banking Results Inspire Cautious Optimism
Some of the largest commercial real estate lenders reported year-over-year revenue declines in the third quarter, but certain leading indicators point to a surprisingly robust commercial real estate lending environment.
“On one level, it seems like things should be worse than they are,” said Matt Anderson, managing director of applied data and research at data analytics company Trepp. “But on the other, the numbers that the banks are reporting are still pretty good — still quite good, actually.”
The most significant indicator is that loan loss provisioning declined in the third quarter for the first time in 2020. Trepp analysis of Citigroup, JPMorgan Chase, Wells Fargo and Bank of America filings shows that the big four banks’ collective loss provisioning returned to pre-coronavirus pandemic levels in Q3.
“They feel like they’ve properly accounted for future losses that will be stemming from any problems in the portfolio,” Anderson said.
The institutional lenders’ loss provisions totaled $5.1B in Q3 2019, the same as that year's fourth quarter. The amount they set aside to offset write-downs ballooned to a combined $23.5B and $32.8B in Q1 and Q2 2020, respectively, before settling back down to an aggregate $5.4B in the most recent quarter.
Though the banks may be in a strong position to handle nonpayment of loans, it isn’t as though CRE lending is completely out of the woods. The full battery of indicators that would signal all is well isn’t yet available.
“There’s probably more that we don’t know than that we do know, both in terms of the true current conditions of those loans and, of course, what the future’s going to look like,” Anderson said.
“It's hard right now because we're really in early days, and we're not seeing as much pressure as I think we will ultimately see, and some of that's from the stimulus,” said John Mackerey, DBRS Morningstar's senior vice president, Global Financial Institutions Group. “It seems to be really just specifically hitting certain sectors.”
Not all bad loans showed up in Q3 reports, Anderson noted. The CARES Act allowed impacted borrowers to seek two rounds of 90-day deferrals on loans before they were marked delinquent. Borrowers who took advantage of those deferrals in, say, April and then again in July would potentially begin to default in October, after the third quarter ended.
Disclosure practices are not uniform from bank to bank, which can make it difficult for analysts to make an industry-wide assessment of delinquencies, defaults and other nonperforming loans. But the numbers that are available, particularly from Wells Fargo, point to problems along asset class lines, not CRE lending in total.
Wells Fargo's nonaccrual CRE loans, or unsecured loans that are more than 90 days overdue, totaled $1.4B in the third quarter, a $126M increase over Q2 that features a $119M spike in office nonaccrual loans. Shopping centers present the largest percentage of nonaccrual loans (30%), followed by office (20%), hotel and motel (12%), and non-shopping center retail (12%).
BofA's commercial real estate nonperforming loans, leases and foreclosed properties totaled $414M in the third quarter, down from $474M in Q2 but still up from $185M in Q3 2019.
Delinquencies and defaults will be important moving forward, but the numbers available now aren't causing Mackerey to hit the panic button.
“I don't view them as kind of alarming levels,” he said. “So we'll see what happens the next few quarters, but I think that at this rate, and given the strong underwriting for these loans, I don't see it kind of moving the needle too much apart from specific portfolios within CRE.”
Anderson said there is still money available, including debt financing. Wells Fargo’s quarter-over-quarter construction lending was up by $825M, according to its Q3 supplemental report. Construction loan performance remains strong, though any trouble actually filling buildings once they deliver could cause concern moving forward.
But Wells Fargo noted its construction loan increase was driven largely by industrial, data centers and multifamily, three of the asset classes that have proven most resilient against the pandemic-induced economic downturn.
JPMorgan’s CRE banking revenue grew from $566M in Q2 to $576M in Q3, according to its supplement. That is a nearly $30M increase from the $547M CRE banking revenue in Q3 2019. Anderson noted that JPMorgan’s CRE financing and refinancing tends to focus on an asset class that is surviving in spite of the pandemic: multifamily.
In September 2008, around the beginning of the Great Financial Crisis, JPMorgan acquired Washington Mutual, which at the time was the U.S. multifamily industry’s most prolific lending bank. For the last decade, Anderson said, multifamily has been the most favored property type for bank lenders.
Long-term concerns surround multifamily, especially assets in densely populated, urban areas. People are moving out of urban multifamily units and into suburban single-family homes, the Urban Land Institute found in a report published last week. But that coronavirus-accelerated trend has yet to impact multifamily lending, Anderson said.
While mitigating factors can temper optimism, factors not related to loan performance temper pessimism over potentially troubling indicators. Bank of America’s quarterly loan yields are down slightly, from 2.64% in Q2 to 2.47% in Q3, according to BofA’s supplemental information packet. A nearly 2% year-over-year drop, from 4.38% in Q3 2019, might on the surface be cause for concern, but the primary trend driving it existed prior to the pandemic.
“That’s mainly being driven by the extremely low interest rate environment that we’re in right now,” Anderson said, noting that interest margins had been on the decline for more than a year.
What would be concerning is if delinquencies, defaults and nonperforming loans spiked, Anderson said. If loan performance problems in the second and third quarters were hidden behind a facade of CARES Act-inspired deferrals, cracks should soon appear, unmasking the deterioration within.
“I think, with the Q4 numbers, that we’ll at that point have a much clearer picture of where things really stand,” Anderson said.
It could get worse, he said, but the decline in loss provisioning is Anderson’s best reason to feel like the industry might just be heading for slightly more placid waters.
“At least from the banks’ perspective, the commercial real estate glass appears to be at least half full, based on their third-quarter earnings and all the details of what they’ve been up to in the third quarter,” Anderson said.