Despite market expectations for higher Treasury yields, interest rates have moved counter to consensus, with 10-year Treasury yields touching a six-month low last week. The decline has coincided with a steady drop in risk aversion, reflected in an easing of commercial real estate lending standards according to survey measures.
The Senior Loan Officer Survey, a quarterly release from the Federal Reserve’s Division of Monetary Affairs, reflects a continued easing in commercial real estate lending standards—whether for construction and land development loans, loans secured by nonfarm nonresidential structures, or loans secured by multifamily structures. (For the past three quarters, the aforementioned three areas of commercial real estate lending have been evaluated by the Fed separately.)
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As shown in Chart 1, more banks reported easing standards than tightening standards over the last quarter (responses were gathered during the first two weeks of April 2014), although the percentage of banks easing standards for construction and land development loans and multifamily loans over the past three months fell modestly from January’s survey.
Similarly, as shown in Chart 2 below, banks continued to report a strengthening, rather than an erosion, in demand; an increased fraction of banks reported stronger demand over the last three months for construction and land development loans and multifamily loans versus the January survey.
As shown in Table 1, the terms relating to loan size and maturity, as well as loan costs (as reflected by the spread over banks’ own cost of funds) have eased in 2014 versus 2013. In contrast, loan-to-value requirements are essentially unchanged, as are debt-service coverage ratios and requirements for take-out financing. While the data suggest a slight willingness by banks to take more risk, it is clear that the ability of commercial real estate collateral to support timely repayment of the loan still remains paramount.
Despite the improvement in borrowing conditions and the reported increase in demand, the actual level of commercial real estate loans outstanding on commercial bank balance sheets remains largely unchanged, however. As shown in Chart 3, the $1.49 trillion in commercial real estate loans outstanding is at the same level it was in Q3 2010. Annual loan growth only turned positive in 2013 (Chart 4), despite the fact that the delinquency rate on commercial real estate loans held by commercial banks, at 2.46% as of December 2013, has fallen every quarter since 2010.
The easing of lending standards by banks is welcome news, especially since the share of loans financed by national banks has jumped dramatically of late—from less than 20% in 2012 to 26% in 2013 (Chart 5 below)—even as the composition of buyers for office properties has remained largely unchanged over the past several years (Chart 6 below).
Moreover, while the level of total CMBS outstanding has continued to decline over the past several years (Chart 7), the fraction of CMBS outstanding collateralized by office properties has fallen even more, leading to office CMBS levels that have declined every month but one over the last year (Chart 8). Even so, office CMBS comprises more than half of the total amount of CMBS outstanding in many places (Table 2), playing an outsized role in the lending markets of several larger metropolitan areas.
While survey measures suggest continued optimism on the part of lenders, underwriting data still signal caution (Table 3). Close monitoring of borrower behavior will be needed to corroborate the improving story being told by lenders in the months ahead.