US banks anticipate slowdown in CRE lending as rates rise

The banking industry is bracing for a drop in commercial real estate lending activity as the Federal Reserve gets more aggressive in raising interest rates.

The Fed's hawkish pivot to a 75-basis-point rate hike at its June meeting is raising red flags about the future of CRE loan growth. Equity analysts believe CRE investors are likely to retreat into safer havens rather than CRE projects.

"A few banks have indicated to us that certain CRE deals no longer make sense due to higher rates and that alternative investments (like the 5-year Treasury at 3.5%) may result in a significant slow down in CRE activity," B. Riley analyst Steve Moss wrote in a June 14 note. "CRE investors are likely to be sensitive to the relative rate of return for a Treasury bond versus a CRE project."

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Moss downgraded a handful of CRE-concentrated banks — The Bank of Princeton, Bridgewater Bancshares Inc., HomeStreet Inc., Peoples Bancorp Inc., New York Community Bancorp Inc. and its merger partner Flagstar Bancorp Inc. — due to the uncertainty regarding future CRE loan growth.

In a note following the Fed's June 15 rate hike, D.A. Davidson analysts echoed the sentiment that CRE lending is at risk.

"Higher interest rates, however, are likely to begin reducing activity and transaction levels, particularly in CRE segments, as investors could become more cautious about adding additional equity into deals to counter higher CAP rates, and proposed transactions may not cash flow, as projections are pressured at higher interest rates," they wrote in the June 16 note.

Banks prepare

Some banks are already feeling the squeeze. While Truist Financial Corp.'s loan growth is exceeding The Fed's H.8 data, CRE loans will likely come in flat to down in the second quarter, CFO Daryl Bible said at an investor conference June 13. However, the executive believes that the lending segment could gain steam in the second half of the year.

When BB&T and SunTrust came together to create Truist, the companies decided to pull back on CRE lending given the companies' overlap in the segment, CEO William Rogers said at an industry conference June 3. Now, the combined company has developed a CRE strategy driven by larger clients, with lots of capital, more sophistication and better selection and diversity, he said.

When it comes to the different segments of CRE, banks believe the office segment will face the most challenges.

U.S. Bancorp, which is holding its CRE portfolio at about $40 billion, is seeing "nice growth" in multifamily and industrial manufacturing, but office could present challenges for the industry, CFO Terrance Dolan said at a conference presentation June 14.

"The area that we continue to just watch is just office space. With return-to-the-office still, I think, in a nascent sort of stage, we want to see how that develops over time," he said. "That's probably the area that we continue to watch and manage down as well."

KeyCorp also thinks office space will feel stress, but the company feels prepared to weather the storm as rates rise given its CRE book concentrations.

"We, by strategy, have focused on multifamily and industrial, which has been the right place through the cycle to be. The area that I think is going to be vulnerable with leverage, I think, is B and C class office space," Chairman, President and CEO Christopher Gorman said at a conference presentation June 13. "You have occupancy in the actual office buildings of 20% and 30% and I don't think that's sustainable. That's something that I think people ought to keep a close eye on."

Fifth Third Bancorp President Timothy Spence said his company is well-positioned for the impending stress on CRE.

"I think we're naturally pretty paranoid. But again, I think we have the benefit of a slightly different business profile," Spence said at a conference presentation June 15. "If you look at the commercial book, the bank [has] maintained ... the lowest allocation to commercial real estate of any of its peers. And we know there are some stress in those sectors that just make up a smaller share of Fifth Third."