A subsidiary of Canada’s Toronto-Dominion Bank, TD Bank, N.A. is one of the top 10 largest banks in the U.S. with an estimated asset value of $1.4 trillion. TD Bank is an active commercial real estate lender across all property types. The bank expanded its commercial real estate lending by 6.8 percent in 2018, issuing a total of $6.6 billion in new loans and renewals. NREI recently spoke with Gregg Gerken, head of commercial real estate business at TD Bank, to hear his views on the current climate for bank lending and what’s ahead for 2020.
NREI: Can you give us a bit of background on your commercial real estate lending activity?
Gregg Gerken: Our fiscal year-end is October 31st and we have not reported our financial results. What I can say is the portfolio itself had grown pretty significantly in spite of the market overall being down in 2018. As we move into 2020, we are in a little bit more of a cautious mode given the length of time of this recovery and some of the cautionary headwinds that we see out there.
NREI: The MBA’s latest quarterly survey showed that the dollar volume for commercial and multifamily mortgage originations for the third quarter was up 24 percent and bank lending specifically was up 44 percent year-over-year. What’s your view on bank lending activity overall?
Gregg Gerken: If you look at 2018, you saw a pretty significant decline in bank activity. (According to the MBA, while mortgage originations overall increased by 3 percent in 2018, loans for commercial bank portfolios declined by 10 percent.) It was down almost every quarter and year-over-year it was down pretty significantly. So, part of the increase in 2019 is banks getting back to what had traditionally been their share of the market. Overall, you have seen somewhat of a steady decline in activity given that CMBS is back in, life companies have been looking for yield, and Fannie and Freddie have been on fire with record originations over the last couple of years.
NREI: Why was the market down last year, was it just a dip in transaction volume or was there some choppiness with rates?
Gregg Gerken: It was very choppy. The MBA’s Origination Index was down for the CMBS market, down for commercial banks, life insurance companies were basically flat, and Fannie and Freddie grew fairly significantly.
NREI: You mentioned that TD is taking a more cautious approach. What is your view on commercial real estate lending currently?
Gregg Gerken: At a high level, we don’t really see anything that could tip the economy into a recession. That said, there are a number of things to keep an eye on. One is just the huge volume and the low interest rate environment that we have been in, which has propped up both volume and prices.
You have a trade war going on that at any moment could get resolved or tip the other way. The consumer has been driving the marketplace, but at some point, we could see employment slowing. Looking at the demographics with a lot of baby boomers nearing the ends of their careers, you could actually start to see a groundswell into retirement, which is great for employment overall, but are the jobs at the same level that they have historically been at? Those are all things that we are keeping an eye on.
We are also seeing a fairly significant divergence in the performance of the different property types. Multifamily is probably the best example of the one that has recovered and sustained the recovery for the majority of the uptick since the recession, followed more recently by industrial, which has performed extremely well. Office has stayed relatively flat and has been a pretty steady performer, but it depends on which locale you are in. The suburban office market has been weak or even down in some markets, while the more urban, southeast and southwest markets have been very strong where there is population growth and jobs being created.
NREI: Given some of the backdrop with the economy, how is that manifesting itself in the loans you are willing to do? What’s more in favor versus out of favor these days?
Gregg Gerken: We have been more cautious with retail over the last three to five years, given the number of store closures, repositioning, and frankly, just the gross amount of retail per person in the United States. We have more square footage dedicated to retail per capita than any other country by a pretty wide margin. Plus, you see the pretty significant and steady growth in e-commerce. When it comes to multifamily, we have been very bullish, primarily because people need to put a roof over their heads, and you saw the homeownership rate decline. At both ends of the demographic barbell, the baby boomers and the millennials, we have seen a move towards renting being the housing preference of choice.
NREI: It’s still a very liquid market, with capital available from a variety of different sources. How do you see banks fitting into the climate these days?
Gregg Gerken: I think banks have adapted well. Competition is not necessarily a bad thing. What we have seen in underwriting since 2009 is a fairly consistent, steady and relatively conservative approach, especially compared to historically. The debt funds have come into the market, and you saw a lot of the private equity funds shift from equity to debt. CMBS is back and is very, very strong from almost being non-existent a few years back. They’ve driven a lot of the single-asset, large execution deals.
Where banks have had to adapt is looking at what the market has available [for] them. Also, given a lot of the concentrations that banks have to real estate in terms of percentage of total loans, we’ve had to adjust underwriting and maybe loosen a little bit around the edges, but not much. I think that discipline overall has stayed very strong. If we have lost a little bit of market share, that’s not necessarily a bad thing, given the total origination volume in the market.
NREI: Have banks changed their position on recourse at all, any loosening there?
Gregg Gerken: You have started to see some non-recourse construction lending, which we don’t really consider. There are examples of deals done in the marketplace where non-recourse construction lending has become a little more prevalent in the construction space. I think it has always been there in the permanent loan market.
NREI: Anecdotally, we’re hearing more about banks going longer on term, with more loans at 5- to 7-year terms. How widespread is that, and is TD Bank doing that?
Gregg Gerken: Once you get past five years, there are fewer banks that will go longer on term. I wouldn’t say that it is prevalent, but it is more common than it has been. We have a fairly steady deposit base. Historically, the concern about banks lending long is that we borrow short with deposits. So, when you lend long it can be a little bit more challenging. But today, with derivatives and swaps available, it’s easier to keep longer term debt on your balance sheet, where you hedge the interest rate risk and the mismatch between the deposits and the loans. We have done some longer term debt, and frankly, it has probably given the bank a little bit more of a competitive edge in some areas, where shorter term duration has been the norm in the bank market.
NREI: There has been a lot of talk about reforms to Fannie and Freddie. What’s your view on proposed reforms?
Gregg Gerken: I think it’s a little early to tell. Obviously, the agencies control a fairly significant amount of the market. The commercial side of the agency business has performed extremely well during the last downturn. It also has been a very strong performer in the recovery. The overall volume that Fannie and Freddie do in the market and their continued growth is probably what the government is most concerned about in terms of sizing. What share of the market do they want to have, and how far have they moved from their original mission of predominantly financing low and moderate income loans and/or in secondary markets, where bank financing was a little less available?
NREI: We have seen some increases in investment in technology related to online residential mortgage lending. Is there also more technology coming into play on the commercial real estate lending side?
Gregg Gerken: On the commercial side, what is fairly common today that didn’t exist just a few years ago is the amount of property-level information that is available. The monitoring of performance for leases and individual properties and the analytics available for underwriting are just amazing compared to what it used to be like. More recently, you’re also starting to see the use of some A.I. products read loan documents and give you red-lined copies, where before that was all done by hand. Those are the two biggest examples that have improved the analytics of a portfolio.
NREI: Any other thoughts on what’s ahead for next year?
Gregg Gerken: TD Bank is a fairly conservative bank to begin with, and we’ve been watching the markets very carefully after seeing the recovery come on strong and continuing for so long. You have started to see banks being concerned about the length of the recovery versus any specific signs that it was slowing down. As we go into 2020, as I mentioned, we have an eye on potential concerns around trade, any slowing of employment growth. A year ago, when we had our crystal ball out, most prognosticators were saying that rates were going to go up and they turned around and went down. So, there are probably a few more risks of recession today than there were a year ago, but overall, there is nothing that would indicate that it is imminent.