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Are Signature Bank’s Real Estate Loans Too “Toxic” to Attract Buyers?

During the three-year period spanning 2020 to 2022, Signature Bank issued $13.4 billion in loans on New York City buildings, according to property research company PincusCo. No other bank issued more commercial mortgages in the city.

We’ve all heard the saying, “One man’s trash is another man’s treasure,” and Signature Bank’s real estate loan portfolio might be the most recent example. After a recent Bloomberg article referred to the failed bank’s commercial real estate loans as “toxic waste,” many industry experts are wondering whether that is an accurate assessment.

Shortly after the Federal Deposit Insurance Corporation (FDIC) announced that a subsidiary of New York Community Bank (NYCB) would take on nearly all of Signature Bank’s deposits and all 40 branches in New York, California, Connecticut, North Carolina, and Nevada, the conversation shifted from its collapse to its loan portfolio.

At the end of 2022, the bank had more than $74.2 billion in total loans, according to its most recent earnings report. However, the deal with NYCB’s subsidiary, Flagstar Bank, didn’t include Signature Bank’s $60 billion portfolio of commercial real estate loans (including a number of multifamily properties primarily concentrated in New York City), commercial loans and single-family residential loans.

The FDIC will begin marketing of unclaimed loan portfolio this summer. The regulator has retained Newmark & Company Real Estate Inc. as an advisor on the sale.

Newmark & Co. did not respond to WMRE’s request for comment.

“Well-seasoned, veteran operators”

Signature Bank’s failure ranks as the third largest failure in U.S. banking history. With its headquarters in Manhattan, the bank was particularly active in New York City’s commercial real estate sector and well-known among the city’s largest property owners. It had relationships with some of the city’s wealthiest local real estate dynasties.

During the three-year period spanning 2020 to 2022, Signature Bank issued $13.4 billion in loans on New York City buildings, according to property research company PincusCo. No other bank issued more commercial mortgages in the city. But though Signature Bank grew its real estate loan book more than fourfold over the past decade, from 2018 to 2022, it actually shifted its lending mix more toward fund lending.

At the end of 2022, real estate loans accounted for 44% of Signature Bank’s $110.4 billion in assets, according to financial filings. Specifically, multifamily accounted for 26% and commercial real estate (including office, retail, industrial and other types of properties) represented 16%.

In January 2023, during Signature Bank’s fourth quarter earnings call, Senior Executive Vice President and COO Eric Howell provided additional details about the financial institution’s real estate portfolio, saying that its portfolio of office loans was about $4 billion with zero in nonaccrual. He pointed out that when the bank originated these loans, loan-to-value rations (LTVs) were in the low 50% range and debt service coverage was north of 140.

“We’ve got ample cushion there to absorb whatever we do see come through in that space,” Howell said in response to an analyst question. “I mean don’t get me wrong, we fully expect that there’s going to be some problems. But quite frankly, we’re just not seeing much right now… we’re dealing with well-seasoned, veteran operators, multigenerational, who own many properties and can divert cash flow as necessary to deal with the ones that might be in trouble. And we’re just not seeing the demise of New York office anywhere near what people are predicting.”

Howell acknowledged that Signature Bank’s multifamily loans were heavily weighted toward properties that were rent-stabilized, making it “really tough” for owners to improve cash flow. He was referring to the Housing Stability & Tenant Protection Act of 2019 that limited potential rent increases and eroded property values. In New York City, nearly a million apartments are “rent-stabilized.”

Stephen Buschbom, research director with data firm Trepp LLC, described rent stabilization as potentially “problematic” for liquidating the portfolio in the current environment. “Given that Signature Bank’s loan portfolio was heavily concentrated in New York City real estate and specifically rent-stabilized apartments, any NYC specific regulation that erodes or inhibits landlords’ ability in raise rents in the future or more generally to increase the value of the property through future investment will be value destroying and adversely impact Signature Bank’s commercial real estate loan portfolio,” he said.  

Potential value destruction

It’s not surprising that Flagstar Bank declined to acquire Signature Bank’s commercial real estate loan portfolio, according to experts. NYCB already has a portfolio of rent-stabilized multifamily assets in New York City, which is roughly 40% bigger than Signature Bank’s.

Analysts point out that multifamily lending has been a stable business for Flagstar’s parent company, NYCB, for decades. Due to below-market rents and loyal tenants, the bank experienced few losses on its multifamily loans.

However, multifamily investors and lenders are a little spooked by a new bill proposed by progressive lawmakers in Albany. The “Good Cause eviction” bill would prevent landlords from raising rents by more than 3% or 1.5 times the annual percent change in the Consumer Price Index.

Moreover, the bill would establish automatic lease renewals for renters, which would limit evictions unless landlords have a “good cause” such as failure to pay rent. If landlords tried to raise rent beyond the threshold outlined above, that would be a legitimate reason for tenants to not pay their rent, by law, and avoid eviction.

Unlike the Housing Stability & Tenant Protection Act of 2019, the “Good Cause eviction” law would apply to every apartment in the state of New York. Critics contend that the bill will lead to value destruction.

“The ‘Good Cause eviction’ bill could materially impair the value of unregulated (market rate) apartments in the state of New York and would be particularly impactful in supply constrained, high-demand markets like New York City,” said Buschbom.

This would be happening at a moment when multifamily property values are already declining compared to recent highs. In February, the Commercial Property Price Index tracked by data firm MSCI Real Assets recorded an 8.7% year-over-year decline in multifamily prices nationally. Prices on all types of properties in the six major metros tracked by the firm fell by 7.1% during the same period.

In addition, sales of multifamily properties nationally fell by 76% year-over-year in February, to just $4.8 billion.

“When rent increases are limited by law, landlords may choose to let their properties deteriorate rather than invest money in repairs and upgrades if the potential returns are too low to justify the investment,” he noted. “This can lead to a decline in the quality and therefore value of rental housing over time, which would adversely impact not just unregulated (market rate) apartments, [but] also has knock-on effects for existing rent-stabilized apartments as well.”

Property owners and lenders anticipate that the sale of Signature Bank’s debt will help set new valuations for New York City property loans. They feel confident that the bank’s loans will trade for less than their existing coupon value. Given the uncertainty surrounding the “Good Cause” eviction bill, buyers will expect a discount to account for the additional risk premium, according to Buschbom.

“Many investors, including debt funds, may not be willing to pay what may seem like a steeply discounted price for Signature Bank’s loan portfolio due to the uncertainty associated with the ‘Good Cause eviction’ bill,” Buschbom said.

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