September 14, 2015

Does spike in commercial real estate loan-to-value ratios bode bubble?

A new report showed that commercial real estate portfolios are carrying their highest loan-to-value ratios since before the financial crisis. It's the latest data point in the debate of whether that part of the economy has entered a bubble.

Two years at more than 100 percent
Moody's Investor Service published data showing that commercial real estate loan-to-value ratios have been above 100 percent for the last two years, according to American Banker. The calculation was across the market and took into account historical rates of return. The measure hit 118 percent for the second quarter. That's higher than it was in late 2007.

A Moody's analyst called it a "warning sign," not evidence of a full-blown bubble.

"It's a concern," Joseph Pucella told American Banker, "but there are differences between the current and prior cycles with CRE. Higher debt-service-coverage ratios should alleviate some of the concern."

Regulators have their eyes fixed warily on commercial real estate loans, much as they've sounded warnings about perceived overextension in the auto loan market.

A frenzy of deal-making
Prices per square foot reached highs not seen since 2009 in New York and Los Angeles, the Wall Street Journal reported. Deal-making has soared in the U.S. The total value of commercial real estate agreements hit $225.1 billion in the first six months of 2015, up by more than a third as compared to that period last year.

Of course, there are strong regional differences. Chicago posted a record high for valuations on sold office buildings in the second quarter. Joining New York and LA with high commercial real estate values in booming Boston, where the sector has risen almost 40 percent in the past three years as compared with the national average of 16 percent, noted the Boston Globe. Some banks are letting standards slip in the frenzy by, for instance, not requiring developers to put their own, personal skin in the game on loans for more than a commercial property's valuation.

An executive for Brookline Bancorp Inc., like many observers, sounded a note of wariness but not panic.

"There's nothing looming that says there's a catastrophe, but there are warnings," said Darryl Fess, the bank's senior vice president for commercial real estate.

Nonperforming loans stay manageable
Another interesting data point is to compare nonperforming loan rates. While they stood at a whopping 10 percent in 2010, only 0.7 percent of borrowers these days have been missing principal and interest payments for more than three months.

The loan growth in commercial real estate mirrors ballooning loan originations across the economy. Total loan balances hit $185 billion in the first quarter.

"The key takeaway," Moody's Purcella told American Banker, "is that asset quality remained stable and improving in the second quarter. But above-average loan growth remains a concern going forward."

Banks can profit from the experience third-party loan advisors have in discerning which parts of their loan portfolios to place on the market and which to hang onto. Any questions or concerns can be discussed with loan sale advisory firm Garnet Capital Advisors.