Banks See Cautionary Signals in Recent Lending Activity

Banks See Cautionary Signals in Recent Lending Activity

Some Report Lower Loan Balances, Signs That Commercial Property Prices Might Be Peaking

BY MARK HESCHMEYER  (via CoStar Group)

Executives at Texas Capital Bancshares are among those at U.S. banks who are watching to see whether property prices may have reached a peak. Photo: CoStar

Executives at Texas Capital Bancshares are among those at U.S. banks who are watching to see whether property prices may have reached a peak. Photo: CoStar

Some banks are beginning to see warning signs that the nation’s near-record stretch of economic growth may be approaching an end.

About one-third of U.S. banks are reporting lower commercial real estate loan balances and originations in their first-quarter earnings, according to a CoStar analysis of earnings announcements and conference calls.

Of course, that means two-thirds of banks are not reporting decreases, but by comparison, in the first quarter of 2008, less than 3% of banks reported shrinking commercial real estate loan volumes. As U.S. economic growth is on pace to reach a record length in July, more executives in various industries are watching for any indication of a potential slowing of growth. That’s brought a closer scrutiny on various aspects of lending.

In another cautionary signal among some banking executives that property values may be peaking, some banks are seeing more commercial real estate loans being paid off than they can originate.

“We’re seeing a lot of signs of asset values really, really peaking with a lot of clients selling assets, which often is an indicator that we are nearing the late end of the cycle,” Keith Cargill, president and chief executive of Texas Capital Bancshares, said in a conference call with analysts to discuss first-quarter financial results. “Rather than chase that and try to overcome those payoffs by booking even more loans and pushing growth, it’s a mistake in our view because through cycle it will just cost us a lot of credit write-offs.”

In addition, such loan payoffs are damping the outlook for continued strong loan growth throughout the rest of the year, according to Terry Dolan, chief financial officer of U.S. Bancorp.

“Our expectation is that [payoffs] will continue to be a bit of a drag throughout the rest of the year just based upon where we’re at in the business cycle,” Dolan said.

F. Morgan Gasior, chairman and chief executive of BankFinancial Corp., had a similar observation.

“The opportunities are getting a little thinner because the market is so mature,” Gasior said. “We were working with the borrower just the other day on a transaction here in Chicago, and the borrower decided not to proceed with the purchase because the profitability was just too thin.”

Gasior, Dolan and Cargill were not alone among bank executives seeing a slowdown in their commercial loan originations. Besides needing to generate more loans to replace the loans being paid off, several banks reported they are strategically focusing on better-performing property types and markets, and on their strongest existing banking relationships.

For John Woods, chief financial officer of Citizens Financial Group, that means focusing on the strongest neighborhoods. Citizens Financial operates in the states of Connecticut, Delaware, Maine, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island and Vermont.

“There’s still attractive opportunities in the footprint in Boston and the Seaport District for example,” Woods said. “And when it comes to office, we typically focus on owner-occupied, so there’s a low-risk type of project that we’re financing.”

“What is flatlining is really multifamily and anything retail,” Woods added. “We’re really not growing those with any kind of significance.”

Those types of comments follow what has already been showing up in commercial property price growth, according to CoStar’s Commercial Repeat Sales Indices. Values are performing better on properties in core markets versus a wider range of properties in secondary and tertiary markets.

CoStar’s value-weighted U.S. Composite Index, which reflects the larger-asset sales common in core markets, increased 1.4% in February over January, contributing to an annual gain of 6.4% in the prior 12 months. That is slightly higher than results from a year ago in the same month.

Meanwhile, CoStar’s equal-weighted U.S. Composite Index, which reflects the more numerous but lower-priced property sales typical of secondary and tertiary markets, slid 0.6% in February over January, posting an annual gain of 5.9% in the prior 12 months. That compares unfavorably to results from a year ago, when the index advanced by 1.4% in February 2018 over the preceding month and increased 13.2% in the previous 12 months.

And it isn’t only bank executives who are expressing concern about the economy reversing course, according to Duke University’s Fuqua School of Business quarterly Global Business Outlook released this month.

“CFOs in the United States tell us that they expect moderate economic growth to continue for the rest of this year, with capital spending expected to grow 5% and employment by 2%,” said survey director John Graham, a finance professor at Duke, in the school’s most recent outlook survey. “However, with each passing quarter, the probability increases that an economic recession will have begun.”

He added that “by the first quarter of 2020, 38% of CFOs believe a recession will have begun, and by the beginning of the year after that, 84% believe that a recession will have begun. So, it appears that we may be in the final stages of this long period of economic growth.”