After witnessing dramatic market changes in the lending environment over the past 14 years, some credit professionals have come to view commercial real estate as relatively safe. Others see CRE as a wolf in sheep's clothing, citing slippage in underwriting standards and pricing as well as marginal players moving back into the market. Panelists at RMA's Annual Risk Management Conference representing the large regional banks in the Southeast, Midwest, and West Coast, discussed the current credit for offices, retail, warehouses, and multifamily commercial real estate. They then moved to the consumer portfolio, Basel II and other compliance issues, incentives and compensation, and more.

Commercial Real Estate

"BB&T's experience in commercial real estate has been excellent--right through the recession and continuing today," said Ken Chalk, chief credit officer. "CRE loan losses have been a lot lower than for C&I, in the low single digits and practically no nonperformers." Chalk felt this to be the case for most banks. "The financial and Fed information we've seen as well as some studies from Moody's all show that our commercial real estate portfolios are performing exceedingly well." BB&T is a $97.9 billion financial holding company headquartered in Winston-Salem, North Carolina.

Why? Chalk pointed to better, more cautious underwriting than was seen back in the 1980s and 1990s, with deals requiring more equity now than 12-15 years ago. More care is taken with appraisals.

"But you also have to consider the external factors," he said. The capital markets have added liquidity and discipline, which was not the case during the previous recession, when CRE was a problem. Low interest rates also have been a strong factor, and any future problems are more about rising interest rates and oversupply than banks' portfolio management.

"If the scenario back in 1991 was driven by the perfect storm, I think the scenario in 2002-03 must be the perfect day," said Kevin Blakely, EVP and chief credit policy officer of Cleveland, Ohio-based KeyCorp, a $90 billion company. "We're not experiencing much in the way of credit quality issues anywhere in the industry, and there is much to be said about the disciplinary effect of the capital markets on publicly traded entities. The availability of conduits allows us to unload products into the market, while at the same time helping to set underwriting standards to ensure we don't get too far out of line." Blakely acknowledged, however, that low interest rates have created an environment that can mask a lot of mistakes; as interest rates rise, so will problems. He also noted some deterioration in underwriting standards--less recourse being given and less equity going into deals. "The condo market is beginning to look a little spooky, particularly in the Southeast," he said. But he believed the overall picture remains strong.

"The argument we hear from the line is that balance sheets are stronger," said James Henry, SEVP and chief credit officer of Bank of the West, a $40 billion California-based commercial bank. "But I'm seeing looser structures in the past 18 months and equity falling to minuscule levels." Henry admitted that his bank's portfolio is mimicking those of BB&T and KeyCorp, but added, "It's where we go from here [that concerns me]."

Henry said that in the West, a number of smaller developers are being acquired. "The mid-level developers are almost all gone because the public companies and the larger private companies cannot get entitlements quickly enough to keep producing the profit levels that they want to produce," he said. "So there has been pressure to work with larger developers on their programs; keeping up to speed with them has been difficult because of the positive aspects of the California and West Coast real estate market."

Chalk said that single-family housing has performed better than other CRE portfolios. With more people moving to the Southeast, the demographics favor single-family construction; low interest rates are another factor in the expansion of single-family housing construction. "Our builders have been selling houses as fast at they can build them," said Chalk. "Also, there is a limit on the supply, because it now takes longer to go through the permitting process--the hurdles of subdivision approval are keeping the supply lower in some of the faster-growing markets." Rising housing prices could be a problem in the long term, but currently demand and supply are about equal.

Blakely agreed that single-family housing has been a very robust market. "I do worry about the effect of rising interest rates," he said, which could cause a considerable slowdown in that market, although it could help multifamily housing. "I think one reason multifamily has been having difficulty is because low interest rates have allowed more people to afford a single-family home." He recalled having lived in the Washington, D.C. market in 1990, where he witnessed the market going from one or two days' worth of product in April to more than a year's worth by the following August. "It can change dramatically over a short period of time, so we need to keep a close watch on these two markets as interest rates begin to shift," he said.