Commercial Investment Real Estate Spring 2020 | Page 38
record of 10 years of sustained growth from
March 1991 to March 2001.
Understanding that a cycle, by defi-
nition, is a “group of events that happen in
a particular order, one following the other,
and are often repeated,” Twain’s quote about
rhymes is inherently true in bull-bear eco-
nomic markets. The Great Recession was the
worst economic downturn in nearly 80 years,
with economic contraction hitting a peak of
2.5 percent of gross domestic product from
2008 to 2009. The economy, as it has done
in previous cycles, rebounded — growing
steadily, if unspectacularly, through the early
2010s. But why didn’t this recovery extend
to community bank loans and assets, whose
proportional growth fell behind the rest of
the economy over this decade-long expan-
sion? Why, after bottoming out in 2008,
didn’t economic growth extend fully into
smaller lending institutions?
Historically, approximately 75 percent
of all community bank loans and mortgages
have been secured by real estate, with a large
amount of those loans and mortgages tied
to commercial projects. The failure of total
community bank loan growth to minimally
match the growth of GDP affects commercial
real estate lending as a whole. Financing is
available; however, loan terms are more re-
strictive than in the past. A few of the more
restrictive changes include:
• Construction loans typically require
higher levels of preleasing for non-res-
idential rental properties and higher
levels of presales for residential “for
sale” projects.
• Upfront equity requirements of 30 to 40
percent are not unusual.
• Amortization periods for term loans
are shorter.
Obviously, these changes make it
more challenging to obtain project financ-
ing from a community bank.
Consolidation is a generational trend
in banking, with the number of U.S. banks
declining by approximately 41 percent in the
last three decades, from 12,615 in 1991 to
5,162 in the third quarter of 2019. Of these,
approximately 92 percent were communi-
ty banks, which regulators often define as
banks with $10 billion or less in total assets,
meaning thousands of smaller operations
have shuttered in the last 30 years. Growth is
equally dismal, with 2018’s 14 new commu-
nity banks being the high-water mark since
the Great Recession. During 2Q2019, only
five new community banks opened.
Between 2017 and 2019, communi-
ty bank loan growth dipped into the red.
These declines were caused by community
banks with thinner capital ratios hoarding
cash to increase their capital ratios, loan
securitization, and increased competition
from regional banks and non-bank lenders,
36
COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE
THE PEOPLE IN YOUR
NEIGHBORHOOD
COMMUNITY BANK LOAN GROWTH
COMPARED TO GROWTH IN GDP
Year* Loan Growth GDP
2009 (1.98%) (2.5%)
2010 (2.16%) 2.6%
2011 (1.61%) 1.6%
2012 3.1% 2.2%
2013 1.0% 1.8%
2014 6.77% 2.5%
2015 6.36% 2.9%
2016 4.53% 1.6%
2017 (0.006%) 2.4%
2018 (0.009%) 2.9%
2019 (1.01%) 2.1% EST
Average 1.46% 1.96%
*Based on 4Q information; 2019 is based on 3Q2019.
leading to fewer opportunities for commu-
nity banks.
In our extended economic recovery,
the total loans of community banks grew
approximately 1.46 percent on average.
During this same period, the U.S. GDP
went from a valley of 2.5 percent contrac-
tion in 2009 to an estimated 2.1 percent of
growth in GDP from 2018 to 2019. Overall,
GDP grew on average approximately 1.96
percent, slightly outpacing the growth in
community bank lending.
Macroeconomics and national finan-
cial trends rarely allow for easy answers. But
when it comes to explaining why smaller
banking institutions are a step behind, four
primary reasons jump to mind.
Increased bank regulations. Follow-
ing the financial crisis, Congress passed the
Dodd-Frank Wall Street Reform and Con-
sumer Protection Act in 2010. Those 2,000
pages were intended to make the banking
system safer, but the unintended conse-
quences of the legislation greatly increased
compliance costs and forced community
banks to be more restrictive in their lending.
Increased competition for commercial real
estate loans continues to force community
banks to decrease pricing to maintain mar-
ket share, negatively impacting their net
interest margin.
Worse still, community banks may
“stretch,” or be more aggressive than their
underwriting policies permit in determining
the loan amount in order, to retain existing
customers or obtain new ones. Assuming
additional credit risk at this point in the cycle
is particularly dangerous. Or saying this an-
other way, are community banks being paid
enough to take on additional credit risk 11
years into an economic expansion?
Federal Reserve monetary policy.
The Fed has changed how it conducts mon-
etary policy. The most significant change af-
fects how community banks pay interest on
excess reserves. Rather than holding excess
reserves, these dollars could be put to a more
optimal use in higher yielding loan growth.
Increased competition from re-
gional banks and non-bank financial in-
stitutions. It’s no secret to any community
bank loan officer and senior management
that these lenders are competing for busi-
ness formerly dominated by community
banks. Many large U.S. based investment
firms have created non-bank lenders — or
shadow banks, as they are often referred — a
$15 trillion market. These non-bank lenders
are typically either divisions or subsidiaries
of large United States investment banks or
entities being formed and supported by pri-
vate equity firms. It is important to note that
these lenders do not receive deposit funding,
and they are largely unregulated. Because of
this, they can make loans that are general-
ly out of reach of community banks, giving
them a significant competitive advantage in
growing loans.
Decline in number of community
banks. Arguably, less community banks
contribute to less loans. As mentioned
earlier, higher levels of preleasing and
presales, greater equity contributions, and
shorter amortization periods for term loans
have become the norm. More restrictive
lending negatively affects all commercial
real estate lending. Developing a business
relationship with your local community
bank which has always been important, is
arguably more important than ever, as the
number of community banks continues to
decrease. Where we’re at in the current eco-
nomic cycle position and the decline in the
number of community banks have had less
effect on growth in community banks loans
compared to the first three factors. But
the commercial real estate industry is still
missing the potential that could be fulfilled
by smaller banking institutions.
Cycles are not static, as the pendu-
lum continually swings from expansion to
contraction and back. In time, community
banks may reverse their contracting trend
and begin to expand. This expansion should
be accompanied by more loan availability for
commercial real estate.
Bradley Gordon, CCIM
Managing member of
B.D. Gordon Consulting LLC
Contact him at [email protected].
SPRING 2020