Is Your Bank on a CRE Treadmill?

February 20, 2018 Maria Abbe

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"Community and regional banks have developed a dangerous reliance on commercial real estate (CRE) lending that is not sustainable. This CRE treadmill is dangerous, and banks must decide how they intend to get off it."

Jim Young and Dallas Wells discuss how your bank can get off the CRE treadmill and diversify its growth.


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Podcast Transcript

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Jim Young: Hi and welcome to the Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the mind of today's best bankers. I'm your host Jim Young, director of communications at PrecisionLender and today I'm joined again by Dallas Wells EVP for international operations here at PrecisionLender. We're going to talk today about a post Dallas wrote on his LinkedIn account and it's titled Banks and the CRE Treadmill. Dallas, thanks for coming on again.
Dallas Wells: Sure, Thanks Jim.
Jim Young: So, we'll get to the treadmill part of this discussion in a bit but first, give us a little bit of background about how you ended up gathering the data you used to write this post.
Dallas Wells: Yeah, sure. Where this came from, we were working on a project to compare PrecisionLender clients to peer groups. We were gathering lots of different data on makeups of the balance sheet and performance and different sizes of banks in different regions. And so as we started sorting that out there was quite a few interesting things that popped out about bank performance and it's one of those things where averages can be a little misleading in that they tell one story but sometimes underneath there's lots of other interesting things going on. So this was one of the popped out that I thought was worth talking about.
Jim Young: So what did you find I guess what you're saying underneath on this one is that you found some stuff about CRE concentrations and believe in the community bank space. Can you kind of share a little bit about what you found.
Dallas Wells: Yeah, sure. Part of what when I say the averages can mislead and hide some things, generally in banking what that means is that the very largest banks and the top 10 or so and actually the top nine I think are all over 250 billion  in assets here in the U.S. And so those top nine hold a gigantic portion of the total industry assets. And so as they go so goes the industry average. When in reality then there's another 5500 that make up a much smaller portion of the assets but it's much of what we think of as the industry. And so those two groups diverge in quite a few places. One of them being the make up of their balance sheet and really where they've grown their loan books over the last 10 years or so.
And so the big finding and I don't think it's a big surprise to anyone is that those smaller banks, community banks and regional banks have ridden the commercial real estate recovery and loaned very heavily into that and that's been the source of their growth and performance for most of the last decade. I think the the important takeaway is we may be getting to a point where that looks a little wobbly and so those banks need to rather than just say we're in it with commercial real estate til the end, step back and take a look and say, is this too much, when do we readjust this to avoid just reliving some of the disasters that we saw back in '08 and '09.
Jim Young: So real quickly, I want to clarify something on there because I think I introduced this by talking about community banks but are we basically talking then about basically anybody but those top 10 banks essentially? Does this apply essentially to regional banks as well?
Dallas Wells: It does. There's lots of ways to classify them and definitely regional banks which we would traditionally call 10 billion to maybe 50 billion in assets. And just because of how the regulations have these sort of arbitrary numbers where the rules change, anything over 50, those banks just become much more complex and and they're just a different sort of animal. So I think in the post I called those super regionals was the term I use for it and there's twenty fiveish of. So you're looking at anything below 50 billion in assets definitely falls under this category and even some of those super regionals are, they're real estate banks, they just do it in a lot more places
Jim Young: Okay. So this is the point in the podcast where I go into my traditional contrarian role which usually ends up with me playing more of the Washington Generals to your Globe Trotters but generally speaking a treadmill is something you want to try to get off and you kind of already touched on this a little bit. But if these banks are particularly suited to land CRE business, this is an area in which they can compete with the really big, big boys and that business is profitable, why is it that we maybe assume that too much of a good thing is a bad thing?
Dallas Wells: Yeah, that's a fair question and that's really the pushback I think that you'll get from any banker as you start to talk about concentrations of commercial real estate. We actually had a couple of clients that jokingly reached out to me after this and like hey, you're killing me, our CRE lenders really hated this article. That's maybe a fair response but I think sometimes the truth does hurt a little bit.
So their argument and I will say that some of them are right. This is not a universal blanket statement but commercial real estate is kind of the ultimate local asset and so those local banks know their markets, they know the builders, the developers, the real estate community, they know who to lend to and who not to more so than the big guys would.
So, you're right that community banks are especially well suited to lend into this. The problem is is that it's making up now a gigantic share of their balance sheets and in fact more than ever before. If you look at the share of commercial real estate loans to their total assets, it's higher now than it was right before the financial crisis. And so it's above 30% of total assets for that community bank group. The other piece of that then is what's going on with commercial real estate prices.
Again, averages can be a little misleading. The real estate market saw a big crash of course in 2009 and '10 and then has slowly recovered over the last 10 years. But if you divide that between residential real estate and commercial real estate, commercial real estate did have a major correction but it was nowhere near what happened in residential real estate and I think I charted prices in there from a price index and basically those prices came back down to what looked like a normal trend line in 2009 and '10 so it has this little hump through the bubble. We kind of came back to normal growth rates but then it was a quick bounce and actually real estate prices within maybe four or five years surpassed the old peak and we're now well above that.
Commercial real estate is also very dependent on interest rates and so low interest rates help fuel that and lots of liquidity help fuel that and both of those things are starting to shift a little bit. So high prices, rising interest rates, we're now very long in a growth cycle. There's lots of things that add up to the potential for, not a disaster like we saw in '08 and '09 but that the growth can't continue like this forever and that growth is really what's driven the growth in the community banking business.
So, this is not Chicken Little, the sky is falling and it's a disaster, everybody out of the real estate market. This is saying, if you want to continue growing you might have to look elsewhere because if you keep trying to pump out 10 plus percent growth by lending into real estate you're going to start doing deals that you'll eventually wish you hadn't.
Jim Young: All right. So I may once again grudgingly concede the point on this. You also kind of give a pretty good explanation for why these banks may have almost no choice but to keep going after CRE business. I can sort of feel the pain of some of these CRE lenders, what you say, hey, you guys are already concentrated but I totally understand why you guys are already concentrated. What's their options at this point?
Dallas Wells: Yeah, that's the tricky part and hence it's a treadmill. It's a little tricky to get off this. And so what we see is there's three approaches that banks are taking. One of them that happened especially quite a bit over the last two years is just sell the darn bank. Look around and say, is this as good as it's going to get for us because we can go to a potential buyer and say look at our growth rates, look at our profitability. If we feel like we're near the peak of that curve maybe this is when we start feeling out that option. And there's nothing wrong with that if you feel like the best answer is for you to pair up with somebody who has the infrastructure and has the ability to help diversify the business a little bit.
You can and what we see a whole bunch of banks doing is just continue business as usual. There are some banks out there who have always been heavily concentrated in real estate. They truly are real estate banks, they're experts in it and they do really well. That's what's tricky is being self-aware enough as an institution to say is that us or have we just ridden a wave and now we need to diversify a little bit so that we don't end up getting stuck.
And so that's the third one which I just called invest now to be competitive, which is again, there's no time like the present. So if you're ever going to try to reshape things and become competitive in CNI lending or some niche of CNI lending, now is the time. Technology is cheaper and more readily available than it's ever been, budgets are healthy, balance sheets are healthy. This is the time to point some resources that something new.
If you're a community bank you can't be all things to all people, you can't overnight become Bank of America and offer everything that they offer. But you can take a good thorough look at the market that you're in or the markets that you're in and say where can we find a niche where we can compete with them. So not on everything but on something specific and go do that, do that really well and get some of your growth there. You don't have to give up on real estate. You'll find another avenue for growth so that if the real estate market does turn you're not left holding the bag.
Jim Young: Yeah, this is, and I'll do again my contractually obligated sports analogy here. We talked about Moneyball and that sort of thing and the way in this case some of the banks we're talking about would be playing sort of that role of the Oakland A's and how do you compete against the New York Yankees. You'll find some areas where there's a little bit of inefficiency out there that are maybe a little undervalued etc. How do you find those I think is maybe where you get, or exploit them is where you get, in baseball it would have been the analytics craze but I think what you're saying is this is where the technology comes into. It's one thing to say we know we got this concentration, we know there's probably something else out there that works but how do you find that and how do you actually for lack of a better word exploit that inefficiency is where the technology would come into play here.
Dallas Wells: Yeah, and I think probably the most likely one that the banks, that almost every community bank would do really well if they focused on it is doing those smaller, what I would call small business loans. The big banks have in many cases, I don't want to say abandoned that market but compared to the rest of their business they don't invest a ton in it because it's hard to be profitable with smaller loans. There's technology out there now that that helps allow you to do that.
And so the small banks are better equipped than anybody to say where can we get rid of the inefficiencies in that and get really good at doing the $200,000 revolving line of credit. You're never going to compete for Berkshire Hathaway's revolver but maybe you can for some of the local businesses. Support their liquidity. Do it in a smart way and do it in an efficient way where you can make that a profitable business. I think there's an avenue there. Some banks are starting to figure out and they're the ones that are going to outperform in the next few years.
Jim Young: All right, that'll do it for this week's show. If you want to listen to more podcasts or check out more of our content you can visit our resource page at or you can head over to our home page there to learn more about the company behind this content.
Finally, if you like what you've been hearing make sure to subscribe to the feed in iTunes, SoundCloud, Google Play or Stitcher. We love to get ratings and feedback on any of those platforms. Until next time, this has been Jim Young for Dallas Wells and you've been listening to The Purposeful Banker.

About the Author

Maria Abbe

As a Content Manager here at PrecisionLender, Maria develops the messaging, stories and content pieces for prospects and current clients – showing them the value in PrecisionLender. Her passion for serving others is evident as she leads the volunteer program here at PrecisionLender. Maria’s ability to be organized and constructive, along with her ability to be practical makes her an exceptional addition to our team.

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