Charting Banking V: commercial real estate
by PlanMaestro
Most people have seen a similar version of this chart with a mountain of commercial real estate problems for banks:
But the fact is that for closed banks the percentage of CRE loans non accruing is much lower than C&D
So it looks like CRE issues have been much exaggerated compared to C&D’s. Part of its better performance up to now is because
- Tighter Underwriting: no zero percent down loans or covenant lite
- Better Collateral: most of it was leverage of already performing properties
- Localized: the effects of the bubble was concentrated in specific sectors like retail
- More Capital: small banks absorbed relatively a larger percentage of these loans while having better capital ratios
But there are also some particular characteristics of CRE loans that make them a better risk
- statistics include owner occupied CRE loans that are much lower risk
- has longer durations, spreading problem loans over several years
- refinancing has a much higher probability of succeeding given that the collateral generates cash
- several of the most problematic CRE loans at the top of the bubble were securitized and sold like MPG’s Orange County acquisition
Some people call this “extend and pretend” and would agree when the cash flow is not present or the collateral is weak. But refinancing was and is an essential part of banking and this was not a CRE construction bubble like the end of the 80s. And for investors this “extend and pretend” has the advantage that progress is more gradual and the underwriting can be evaluated without sudden NPA collapses like could happen with C&D loans.
Concluding, for investors a large percentage of CRE loans is a risk but this risk is much easier to bound than C&D’s. Look for:
- High percentage of owner occupied
- Stabilizing CRE non performing assets, provisions and charge off trends. At this stage of the cycle should indicate good underwriting
- Small concentration of loans in sectors with excesses like for example retail and hotels
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In 2009 FDEF said they have around 88,000 CRE due in that year, and this year the amount due is roughly the same. I think if they are doing OK with that amount of CRE due last year, then things will probably be even better this year, since the overall economy this year is better than last year.
FBMI only discloses Commercial and Agricultural and construction dues within one year, 1-5 years and after 5 years, but no CRE disclosure. I am trying to call them to push them to disclose more.
Anything that you find will be much welcomed, liking very much both of them
Hi Plan,
I talked with FBMI’s controllers on Friday, and got some interesting stuff:
1. Their CRE due within one year for 2009 is 151M, and for 2010 is 98M. With significantly less CRE due this year, unless the loan grade is much lower than last year’s dues, it is unlikely that NPA performance would be worse. I think this year’s NPA for CRE will only be better because of the much less CRE dues.
2. Their CRE’s owner occupancy rate is 58% and 56% for 2009 and 2010 separately, which sounds good to me. They said their CRE loans have only one term: 15 year fixed rate amortization, and a balloon payment after five years. They said the loans usually get refinanced when the balloon payment is due.
3. Their loan to value ratio for CRE and construction are 85% and 60% separately, which sounds conservative.
4. Only a tiny amount of CRE loans are made in Detroit. Most of their loans are in central and south west Michigan, which they said the economy is relatively good.
5. I asked them which competitor they appreciate. They said Chemical bank is doing pretty well. So I will check that one out.
Regarding CRE loans refinance, I have one question for you. With the CRE value about 40% lower than peak, they probably have to get refinanced by making a bulk cash payment to get the LTV down to below 85%? If this is true, then many companies with cash problems cannot do the refinance, and they cannot make the balloon payment either.
Cheers!
Zehua
That is great info! The 85% LTV is not really that conservative, but the 60% glad they have it. FBMI looks great and as you imagine it is my second Michigan pick.
Ready for the KBW conference?
I just noticed that I did not answer your question. The answer you may not like it: it depends. Depends on how strong is the bank, on how good income are the properties producing, and the relationship between the bank and the developer/owner (maybe there are other properties/projects?)
I read your post about that conference but I am not sure what it means. You used the term “we”, so I think you are going to hold that conference?
Maybe I should change it to I then, I meant the funds I manage. It is a conference by an investment bank and all these companies are presenting.
Oh, I also forgot to add. FBMI controller said 90% of their CREs are recourse loans.
I think I learned a lot more about CRE loans by reading your MPG posts. I will keep learning REIT stuff. Is this a limited partnership? Sounds like so.
KRG seems to be a good REIT. I have not taken a detailed look yet. I think for limited partnerships, the best time to start tracking is when they stopped cash distribution, and buy when things are better and we are somewhat sure cash distribution will resume.
You nailed the REIT/MLP strategy
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