Introduced in 1937 in an Oklahoma Humpty Dumpty supermarket, the shopping cart has proven to increase per person sales and extend shopping time. A boost to many retail establishments, it is often said to be a predictor of retail health. More shopping cart sales equals more store openings. The problem is that sales are slowing. This is germane to banks as commercial real estate exposure related to retail property financing composes an estimated 22% of community bank commercial real estate (to also include mixed use).
Tag: commercial real estate
Having more bankers to throw at a borrower or more assets to flaunt does not make a bank more effective. Strategy beats size every time, but bankers need to be smart how to position themselves against large banks. When it comes to loan mix, community banks need to be careful to assemble their assets with enterprise risk in mind. In particular, the increase in commercial real estate (CRE) and specifically, High Volatility Commercial Real Estate (HVCRE) is starting to be a concern.
When a bank forecloses on commercial property (or has the option to foreclose) there is always a question of do you spend energy working out the property in hopes that the value comes back or do you sell the property and take the capital charge? To answer the question, we looked at analysis on 150 loans whose underlying financed properties had payment problem and analyzed appraised values over a period of time to determine when a bank should either push the borrower to liquidate the property or foreclose and liquidate the property themselves.
It is a long held precept in banking that when lending on a commercial property, the majority of lease terms should extend past a loan’s maturity. For example, if most of the leases are three years in term, then a bank will often only want to make a three-year loan with the belief that the contractual string of lease cash flows will mitigate credit risk. Not only may this logic be flawed and have no basis in empirical evidence, but creating a shorter loan term to match the leases may actually increase the risk of the loan.
On this Earth Day, we are happy to report that doing right by the Earth can also help your borrowers and shareholders. When you underwrite your next loan on a commercial property, it might make sense to understand the property’s “walkability” or ability to walk from the property to nearby amenities such as public transportation, markets, parks and shops. The easier it is to get from your collateral the more likely that property will appreciate in a good market and hold its value in a down market. This goes for office, retail and multifamily.
In loan pricing and structuring, our loan trading and hedging desk often sees dozens of loans per day. We look at loans from banks all across the nation, including our own, and one area that could be improved is the quantification of lease risk in commercial real estate. Unfortunately, there is not an industry accepted methodology for quantifying the risk, but we would like to start to put forward a couple metrics.
Like Degas obsessed with dancers, bankers have been brought up to obsess over the composition of their loan portfolio. Egged on by our examiners, auditors and random pundits, we slice and dice our loan portfolios as if it means something and pat ourselves on the back when we can show a nice pie chart with lots of even looking slices. The reality is many of our sectors move together and offer little in the way of diversification. When the economy turns, tenants aren’t looking for new office space any more than they are looking for new industrial space.
Last week the RadioShack earnings announcement and restatement that it will close 1,100 locations sent bankers scrambling back to their credit files to see if the beleaguered electronics chain composed any part of their commercial real estate rent rolls. It turns out that that for about 100 loans, there is exposure with an estimate of 36 of these at community banks. Luckily, Radio Shack has been downsizing and has gone to smaller and smaller footprints so that on average, the stores now make up less than 10% of the rentable space at these retail centers.
2013 property cash flows are starting to come in at many lenders and we have been taking a look at the data to see what insights can be gleaned that could give us an advantage. Combining bank data with data from the public markets, we can get a statistically valid sample size of over $130B worth of properties in almost all major metro and suburban markets (about 14% of the total CRE market). The below data may help banks when pricing and will give a clearer view of the risk profile when underwriting.