U.S. banks increased their exposure to riskier commercial real estate loans in the second quarter, but loan balances were still lower than the year-ago period as banks remain cautious on the sector.
The U.S. banking industry's exposure to high-volatility commercial real estate increased 15.0% quarter over quarter to $43.49 billion in the second quarter, according to analysis by S&P Global Market Intelligence. While the sector provided some much-needed loan growth, the total remains 4.9% lower than the year-ago quarter, and several bankers have said they remain wary of commercial real estate credit performance as society continues to navigate the COVID-19 pandemic. High-volatility commercial real estate, or HVCRE, loans include acquisition, development or construction loans for income-producing commercial real estate, with some exclusions.
Wells Fargo & Co. topped the list of 20 banks with the highest HVCRE loan balances at the end of the second quarter. The bank also recorded the largest quarter-over-quarter increase among the banks with the most HVCRE loans, up 29.7% from March 31 to a second-quarter balance of $3.44 billion. Still, the bank's management said they were approaching the sector cautiously.
"While the overall outlook for commercial real estate continued to improve, we remain focused on the areas most impacted by the pandemic," said Wells Fargo CFO Michael Santomassimo during the bank's second-quarter earnings call.
"The reopening of the economy has continued to have a positive impact on retail and hotel as cash flow has improved. While losses and problem loans in office have been very low, we continue to monitor this sector as longer-term demand trends may be influenced by changes in hybrid work-from-home models. It's also important to note that even with the reserve release in the second quarter, our coverage ratio for commercial real estate loans was still higher than it was a year ago," Santomassimo said.
Another bank with a large increase in HVCRE balances was Mississippi-based BancorpSouth Bank, which posted a 25.6% linked-quarter increase to $741.8 million as of June 30.
U.S. banks are struggling with loan growth, and there might be some opportunity in CRE. The industry's aggregate loan balance for all types of CRE rose 2.81% to $2.080 trillion during the period, marking the largest sequential gain since the first quarter of 2020, according to data compiled by S&P Global Market Intelligence.
Demand appears to be rebounding faster than lender confidence. The Federal Reserve Board's July 2021 senior loan officer opinion survey showed 32.4% of respondents reported stronger demand for construction and land development loans, compared to 9.9% saying demand had weakened over the previous three months. The remainder of respondents reported no change. By contrast, only 9.9% of respondents reported easier lending standards for construction loans, compared to 2.8% reporting tightened standards.
Even amid some green shoots in loan growth, several banks are keeping a close eye on their CRE exposures, particularly to hotels, offices and other sectors heavily affected by the COVID-19 pandemic.
San Francisco-based First Republic Bank, which saw its HVCRE exposure drop 20% during the second quarter to $299.2 million, is staying conservative on multifamily and CRE loans, said President and co-CEO Hafize Gaye Erkan during the second-quarter earnings call.
"We don't do much office, but just as general market color, office remains soft in the city centers," Erkan said, adding there should be clarity as employees return to offices. "We have a very limited exposure to CRE retail and hospitality. While we are seeing positive trends as hotel occupancy rates are rising, it's still uncertain. It depends on the global tourism and business travel. But we will continue to do safe deals, which tend to be mostly refinanced, with experienced owner-managers that value our service and holistic banking relationship."
New York-based M&T Bank Corp. is finding ways to meet the needs of its CRE clients without using its balance sheet, Chairman and CEO Rene Jones said during a recent conference hosted by Barclays. M&T's HVCRE loan balance declined 7.3% during the second quarter, standing at $505.2 million as of June 30.
"I think it's sort of a modernization of our capabilities in that space. Ultimately, it will allow us to carry lower capital," Jones said.
