Cautious Banks Cede CRE Lending Ground To Private Capital

Banks of all sizes are shrinking their commercial real estate loan portfolios as sponsors move debt off balance sheets faster than financial institutions, facing competition for loans from private credit, can sign new deals. 

A flood of private capital is likely to keep siphoning deal flow from banks, which have cut their credit risk exposure to the sector as new lending lags. The gap is expected to widen as fund managers look to deploy multiple years’ worth of fundraising for distressed assets that haven't widely materialized. 

Debt funds are so eager to deploy cash that they are reaching out to developers with projects before they are completed to pitch them on bridge loans, said J.C. de Ona, Southeast division president at Centennial Bank.

“They're not even stabilized yet, and I'm seeing these funds come in and offer to cash them out at low rates to get to stabilization,” he said. 

Most of the largest banks have seen their real estate loan portfolios shrink in the third quarter compared to the prior year.

Wells Fargo’s CRE debt portfolio was 8% smaller while U.S. Bank’s CRE debt holdings shrank by 5%. Bank of America and PNC reported smaller declines, according to a Bisnow analysis of quarterly reports. CRE portfolios grew by 3% at Citi and by 1% at JPMorgan Chase.

Regional banks are also paring back old, bad CRE debt to make way for new loans.

Home Bancshares, Centennial’s publicly traded parent company, had a $5.5B commercial real estate loan book at the end of September, $58M smaller than its CRE portfolio at the middle of the year. At the same time, the conglomerate had a record $123.6M in net income as sponsors paid down debt. 

The story is the same at Bank OZK, the regional bank that plays an outsized role in U.S. commercial real estate construction lending. The Arkansas-based bank reported a record $2.4B in loan repayment volume for the third quarter, doubling the year-to-date total while originating just $700M in new real estate debt, at least a five-year low. 

CEO George Gleason told analysts on the firm’s third-quarter earnings call on Oct. 17 that management had expected the imbalance. Paydowns increased after the Federal Reserve cut its benchmark interest rate, helping make refinancing a more attractive prospect for sponsors holding on to costlier short-term extensions.  

The low-volume third-quarter originations likely marks the floor for Bank OZK — Gleason called it an anomaly on the earnings call — but new loan volume at the bank has lagged compared to the prior year for each of the last five quarters. The significant amount of private liquidity looking to fund projects has continued to keep banks largely sidelined. 

“You've got a situation where you've got too many lenders chasing too few projects. That's leading to some structures, pricing and leverage points that we would not go to,” Gleason said. 

While banks and private credit are chasing the same customers, they generally have slightly different goals. Banks are more likely to be looking for stable returns, whereas private capital is often looking for higher returns on shorter timelines, leading to riskier loan structures.

Banks are also subject to regulations related to their underwriting standards and overall debt balances that private funds don’t have to follow. 

Wells Fargo is looking to underwrite more CRE debt across most sectors, but it is being selective with new projects as existing customers pay off loans at a faster rate. 

“We are lending across all the different categories in the commercial real estate space, including office, where we think there are quality properties with the right sponsors,” Wells Fargo Chief Financial Officer Michael Santomassimo said.

Large financial institutions are taking losses on loans after years of pushing out troubled debt, but the write-downs haven’t been large enough to hold back strong earnings and robust profits this year. That has pushed down the number of nonperforming or criticized loans across the largest financial institutions, which have in turn begun cutting their allowances for credit losses. 

Wells Fargo realized $107M in charge-offs related to CRE in the third quarter, its highest volume this year but lower than each of the last two quarters of 2024. At the same time, it cut its allowance for credit losses in CRE as a percent of its holdings in the sector by 30 basis points.

Bank of America cut its credit reserve related to real estate to just over $1B from $1.3B at the end of last year and is budgeting for fewer losses as a proportion of its total CRE loan book. 

Bank OZK added $14M to its allowance for credit losses in the third quarter, its smallest quarterly increase across a 13-quarter buildup of $680M. 

The size of the bank’s criticized loan portfolio shrank by $92M after it sold its largest foreclosed asset, part of the stalled Lincoln Yards megaproject in Chicago, and realized just a $5.1M charge-off in the deal. The bank’s $79M in remaining foreclosed assets primarily consists of three real estate properties, two of which are under contract to sell, according to the bank.

Financial institutions are cutting their credit loss provisions in part because they have moved troubled loans off their balance sheets. But it also reflects a return to cautious optimism around CRE that can be traced back to the end of last year.

Investment sales were up more than 25% in the first half of the year, and the influx of private capital has whittled away at the wall of debt maturities built up by short-term loan extensions.

“We're seeing signs of improvement in the market. I'm not seeing a cascading level of problems developing. I'm seeing one-offs here and there,” said John Buran, CEO of New York-based Flushing Bank. “We're not seeing any real systemic problems in credit.”

Even the office sector, beaten down by weak demand during the work-from-home era of the pandemic, is showing signs of life. The sector had $26B in sales in the first half of the year, up 42% from a year earlier.

Tenant activity is picking up as industrial occupiers make long-delayed decisions and office users continue to reset their footprints to align with postpandemic strategies, which have generally included a return-to-office mandate. National office vacancy declined in the third quarter for the first time since 2019, helped along by office-to-apartment conversions at older properties.

The Fed’s rate cut in September further boosted sentiment among investors, which nearly universally expect another rate cut next week and again in December. 

A stable rate outlook has provided a firmer underwriting foundation, pushing some owners to refinance loans rather than continue with costly extensions. But there are still enough deals where sellers are taking large write-downs that banks remain wary of fully rejoining the fray. 

“That should start to clear up shortly and, as that clears up, you'll see more and more bank lending,” Buran said.

But banks will still be competing with private equity to win those deals when they do return to the market. 

De Ona hasn’t seen any of Centennial Bank’s customers take up a private equity firm’s unsolicited offer to refinance their construction loan before the project has been stabilized, but he said he expects some sponsors eventually will. 

De Ona said he usually sees the same names when sizing opportunities in his region, which includes Miami, a nexus of development during the pandemic that continues to attract capital and massive new developments. There are usually a couple of banks competing against a handful of funds, and the private capital is increasingly offering better deals, he said. 

“They're definitely getting leaner on pricing,” de Ona said, referring to where interest rates land on offers. “They've always been more aggressive on structure and leverage and higher on pricing, but I've seen their pricing come down.”