Low interest rates and housing demand drive lending

(This article originally ran in Finance & Commerce, Minneapolis, MN, another Dolan Media publication).

The story line at most local commercial banks this summer is a familiar one: It starts and ends with interest rates and the housing market.

Long-term interest rates that still linger around 4 percent have been the key driver in keeping housing developers on the epic building spree they've enjoyed for several years.

And all that building has kept construction and development lenders busy, too. Four lenders said that condominium, town home and single-family developments are contributing to a solid first half of 2005 - in a business climate that would otherwise be pretty lackluster.

The number of condo projects hasn't slowed down at all in the last 12 months, and really, that's amazing, said Terry Kriesel, senior vice president for CRE lending at Bremer Bank.

Amazing, because last year's production of 2,136 condo units was 250 more than in the previous 10 years combined, according to DSU Research's Market Viewpoint, and the pace shows no signs of abating.

Extremely low mortgage interest rates and some innovative, low- cost-of-entry mortgages get much of the credit for the resilience of that market.

But a huge pipeline driven by interest rates may create perils, too: What happens when mortgage rates bounce back up 300 basis points? Won't the buyer market evaporate, leaving a glut of unsold condos in its wake?

A closer look at the condo market points to a hedge that lenders and developers can create against a rate-related collapse, said Dan Poppe, managing director for CRE lending at Excel Bank.

The condos that Poppe's clients are planning target opposite ends of the spectrum - luxury and affordable buyers.

Those two groups don't seem to be affected too much by interest rates, he said.

At the luxury end, that's not a surprise; many buyers don't require much leverage to buy a home. And on the affordable side - units at $300,000 or less - buyers are largely middle-income empty- nesters who also have plenty of cash in their pockets.

They're leaving a single-family home that's already paid for, Poppe said, noting the proceeds can cover much of the purchase price.

Still, lenders are watching the fundamentals on condo proposals closely. They're demanding presales - with down payments in the 5 percent range - of 30 percent to 50 percent, and they're looking for projects that promise success, either because of strong locations or because the developer has a proven record and enough financial heft to cover a slowdown in sales.

Other bright stars for lenders and developers continue to be the retail and, at a smaller scale, the medical office markets.

But industrial projects are also beginning to show signs of life after three quarters of positive absorption.

At least we're seeing spec industrial plans that are getting to the drawing board, and we haven't seen that for a long time, said Glenn Sansburn, senior vice president at Well Fargo Bank Minnesota.

All four lenders said their deal pace is at or above last year's strong level. But they also pointed to potential challenges.

One of them comes from a heated-up competitive environment. The legion of recent bank startups and increased activity by both large national banks and by many small, outstate banks have swelled the lender ranks and their appetites for loans.

The result is a bidding battle that Poppe and M&I Bank's CRE manager Mark Johnson said have cut the margins they earn on each loan by about 25 basis points over the last year.

The impact of that competitive pressure appears on a deal-by- deal basis, Johnson said.

For instance, we bid on a loan with someone who'd worked with us before. We thought we had a good offer and a good chance to get the loan. But then a smaller bank came in and killed us on pricing and killed us by a big margin, he said.

That bank probably won't repeat its generous bid in the Twin Cities anytime soon, Johnson said, but other eager new entries will, keeping the pressure on loan pricing.

Borrowers are also moving their loans more rapidly away from their bank's short-term, floating-rate loans to long-term, fixed- rate loans from institutional or Wall Street lenders.

With prices on those long-term loans declining to their lowest levels in memory, Kriesel said, We're telling our borrowers to go. If they can get a 10-year loan for 5.2 percent, that's the best thing for them and for us in the long run.

That migration has meant a major shift in the constituents in Bremer's portfolio, dropping fixed-rate term loans from 50 percent of the portfolio in 2002 to 20 percent today.

So far, that rapid migration has been offset by growth in Bremer's housing and medical office portfolios, Kriesel said, and by a picked-up pace among buyers who are renovating and repositioning outdated industrial and office buildings.

And finally there are the skyrocketing land prices. Developers are pricing those high costs into their unit prices, but the size of those increases still make lenders - and everybody else - a little fidgety.

When the long-term [interest] rates do trend up, we wonder how that's going to affect the absorption of those units, Sansburn said.

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