Some U.S. bankers think animal spirits are running amok in commercial real estate.
During the first week of third-quarter earnings season, several bankers said they were pulling back from CRE due to the competitive landscape or "late-cycle" concerns, which suggests the sector could be headed for a downturn. Home BancShares Inc. Chairman Johnny Allison did not hold back during his bank's Oct. 17 earnings call, directly comparing recent exuberance to the 2008 financial crisis
"These are really dangerous times for banks," he said, calling out competitors for pursuing a "race to the dumbest" deal. He said lenders are offering nonrecourse loans with rates less than 4% and leverage of 80%, adding that the market has become particularly frothy since the Federal Reserve cut rates. Over the time the Fed dropped its benchmark by 50 basis points, lenders have lowered their rates by 150 basis points to 200 basis points, Allison said.
"It was kind of crazy, it was almost like they turned out the wild animals," Allison said, according to a transcript.
Allison was not the only banker to express concerns about CRE. Executives at the two largest banks by CRE holdings as of the second quarter — JPMorgan Chase & Co. and Wells Fargo & Co. — both talked about pulling back due to cyclical concerns.
Wells Fargo CFO John Shrewsberry said there were "lots of nonbank competitors" in CRE, raising "late-cycle" concerns. Recent data show debt funds have claimed more market share and have recently passed life insurance companies in overall share. He said Wells Fargo was being careful to not follow the market, only closing loans that meet the bank's pricing and underwriting requirements. With so many lenders fighting for CRE debt, Shrewsberry said the bank's credit quality is improving by the quarter as fringe loans self-select out of the bank's portfolio.
"Your weakest loans end up getting refinanced away from you, which is also late-cycle behavior," he said.
JPMorgan's executives offered a similar assessment. CFO Jennifer Piepszak said the bank's CRE exposure was relatively flat, as some gains in commercial term lending were offset by declines in real estate banking. "We remain selective given where we are in the cycle," she said, according to a transcript.
U.S. Bancorp also said it is ceding market share to more aggressive competitors. The bank's CRE holdings declined by 1.4% from the year-ago period in the third quarter, continuing an ongoing trend. A year ago, the bank's CRE portfolio had shrank 5.0% over the previous year.
"Some of the declines that you're seeing are really a function of some of the credit components that we're seeing our competitors move to that we're not comfortable with," said Chairman, President and CEO Andrew Cecere on the bank's earnings call.
Even banks that grew CRE loans in the third quarter expressed caution. In the second quarter, Bank OZK had the highest concentration of CRE construction debt relative to risk-based capital among the banks that exceeded regulatory guidance. Executives said the bank originated its largest CRE loan ever in the third quarter and originations increased by 77% from the linked quarter.
During the bank's earnings call, an analyst asked why the bank was so active since it had previously expressed skepticism about the CRE cycle. Chairman and CEO George Gleason II said the bank's origination of very large credits was actually a result of not following a CRE market that has become increasingly competitive.
"In a market where competition is intense and pricing is aggressive on a lot of middle-sized transactions, where we add a lot of value is on very complex transactions," he said.
At the same time, commercial real estate has been the source of irrational exuberance concerns for years. Banking regulators issued guidance more than a decade ago that expressed concern about commercial real estate concentrations. However, when the 2008 financial crash hit, commercial real estate fared much better than residential real estate. And real estate investors have been saying commercial real estate markets were frothy or in the late innings of the cycle for more than four years now.