Garnet Capital Advisors Blog

August 23, 2016

CRM Bubble: Is It Real & What Does It Mean?

Banks need to start tightening underwriting standards to reduce the risk of CRM defaults.

We all know the potential dangers of soaring real estate prices and rapid growth of mortgage portfolios over a short period of time, and it starts with a 'B'.

While that word may have been 'boom' over the recent past when it comes to the commercial real estate market, it could soon turn into 'bubble' if certain steps aren't taken.

The combination of brisk commercial real estate growth along with looser underwriting standards can easily and quickly lead to a potential CRM bubble.

Is this mere speculation? Or is it a possible reality in the near future?

Underwriting Practices Could Spell Danger

According to the Office of the Comptroller of the Currency (OCC), loan growth in the commercial real estate realm has been strong. Yet such findings also accompany other discoveries, including looser underwriting standards, less stringent agreements, lengthened maturities, longer interest-only periods, and limited guarantor criteria.

Such an environment lends itself to heightened credit risk for lenders, placing them in a more vulnerable position to borrowers who default on their loans.

It's a scenario that's already been played out in the US. 2008 and the years leading up to it are a testament to what can happen when lending practices start relaxing. Back then, real estate prices were increasing at a rapid pace as demand for home ownership through government-backed programs increased. Mortgages were being made more widely available to consumers thanks to programs offered by Fannie Mae and Freddie Mac. It was impossible for real estate to appreciate at such a pace for the long haul, and the bubble eventually burst.

Subprime mortgages - those offered to consumers with less-than-perfect credit scores - made up 20 percent of the residential mortgage market in 2006. By early 2008, banks started seeing more and more residential mortgage defaults from this cohort, leading to a host of foreclosures.

Reassessing the proportion of CRM loans on portfolios can help banks and lenders minimize risk.

As far as the current CRM lending practices are concerned, regulators view the easing underwriting standards as a potential future credit risk. The extended low-interest environment can be partially blamed, which has made borrowing much more affordable. As more and more borrowers apply for mortgages amidst such an environment, banks have been competing for their business. As such, they've been loosening their underwriting standards in an effort to make their packages more attractive.

The Federal Reserve is also concerned that prices for the collateral in the commercial real estate market may have climbed too far too fast, outpacing rental income. CRE valuations are becoming increasingly vulnerable to negative external shocks, which could impose stability risks.

Is a CRM bubble imminent? Only time will tell, but with an increase in the number of loans on the books of lenders and an rollback on underwriting standards, a bubble is possible.

Real estate bubbles wreak havoc on the economy, which is where the OCC comes into the picture. This government agency looks out for any signs or trends that may be leading to a bubble. Right now, the signs seem to be there.

Assessing Loan Portfolios

What banks and lenders need to do is take a closer look at their loan portfolios to identify what percentage CRM loans make, and how risky such loans are. Underwriting standards need to be tightened, maturity dates need to be shortened, and guarantor requirements need to be more stringent.

Having a seasoned loan sale advisor like Garnet Capital can be monumental at revamping loan portfolios to ensure only the safest and most profitable loan assets are included. These experts in the loan sale advisory realm can help banks and lenders assess how safe it is to have a large proportion of their loan portfolios in CRM. Not only will this significantly reduce risk, it will also ensure maximum profitability.

To discover more about how Garnet Capital can help optimize your loan portfolio, register for our online portfolio auction system today.