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Regulators Voice Real Estate Angst

The high concentration of commercial real estate loans made by community banks is gaining the attention of the chief officer of the Office of the Comptroller of the Currency (OCC). John C. Dugan recently said his agency's concern is rising at a time of significant market disruptions and declining house and condominium sales and values.

It is no secret that bank regulators have been vocal about this topic for some time now. From speeches by Federal Deposit Insurance Corp. Chairman Sheila Blair to Fed Chairman Ben Bernanke, the drumbeat has been rising that banks have too much exposure to a potential real estate downturn. That exposure is not limited to real estate loans on their books, but positions in mortgage-backed securities as well.

Regulators' rule of asset concentrations prohibits small banks from having real estate-related obligations that exceed 25% of their primary capital, and more than 2% of total assets for larger institutions. Some banks exceeded these limits recently and have had to raise additional capital to satisfy examiners.

Nevertheless, some industry observers believe there is little news in regulators' recent statements. “Remember it is the function of these regulators to keep an eye on how much banks are exposed to risk,” remarked Jamie Woodwell, senior director of commercial and multifamily research, during the MBA's recent convention in Orlando. Woodwell believes the exposure is benign at this point of the real estate cycle, but remains open to what regulators uncover.

Taking the lead

Yet, a more significant development has been quietly emerging. Banks are seeking to curb their exposure to real estate by establishing an outlet for these related loans. Some have created commercial real estate loan broker shops that will enable them to continue making real estate deals without pushing them into capital non-compliance.

Houston-based Texas Citizens Bank N.A. has created a commercial mortgage funding division called Citizens Capital Funding and hired ex-banker Gary Pool as regional director. Pool will originate small-balance commercial real estate loans and sell them to other lenders, functioning like a mortgage broker.

Similarly, James Howell, an Arizona-based mortgage broker was hired in late 2007 by Irwin Union Bank of Arizona to head up a commercial real estate finance business that places loans at various funding shops and other duties.

With these moves, the banks are following the lead from giants like Wells Fargo and Wachovia Securities, and accomplish at least two goals. First, they meet the needs of deposit customers by providing real estate loans beyond the capacity of the banks. Second, the banks can now provide more real estate loans to a segment that is increasingly seeking refuge from capital markets fallout.

Outlets for loans

Many non-bank lenders are altogether exiting the commercial property business or choosing to focus on higher-quality multifamily deals that can be easily traded or sold to Fannie Mae and Freddie Mac. This leaves an opening for many nonconforming deals, and community and regional banks aim to capture that business.

Both Pool and Howell admit they are open to co-brokering commercial real estate loans, so they are not aiming to replace the nation's army of commercial mortgage brokers. They've both found the best opportunities in the small-balance arena. Mortgage brokers accounted for about 70% of the loans written in the small-balance commercial real estate arena in 2007, reports Stamford, Conn.-based Boxwood Means, which tracks loans under $5 million.

Strong contenders like Indymac Bank's commercial lending division, specialty lenders Silver Hill Financial and InterBay Funding, and giants RBC Capital, Lehman Brothers Small Business Finance, GE Real Estate and others are all vying for the small-balance commercial marketplace today. As a result, community and regional banks are being welcome into the loan placement business.

So while regulators continue to stir about banks' exposure to commercial real estate, there may be a reprieve. After the real estate-induced meltdown regulators faced in the S&L crisis of the late 1980s, few are prepared to argue with the concerns of OCC. And the very banks are seeking to head off such a crisis by acting as mortgage brokers, thereby providing an early release valve for high concentrations of commercial real estate loans.

W. Joseph Caton is managing director of Waterbury, Conn.-based Hartford One Group, a real estate finance consultant.

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