In the wake of failures of Silicon Valley and Signature banks this March, media outlets have been awash with speculation that the regional bank sector, and with it, commercial real estate, were headed for a crisis similar to the one seen during the Great Financial Crisis (GFC).
Such takes might get another boost this week, as First Republic Bank’s shares lost about 50% of their value on Tuesday as it became known customers withdrew $102 billion from the bank in the first quarter, more than half of the total value of the deposits First Republic held at the end of 2022.
However, many of the articles forecasting a devastating credit crisis in the commercial real estate sector have been based on incorrect assumptions and don’t accurately reflect what's happening with bank lenders, according to WMRE sources.
For example, a recent Moody’s Analytics report points out that while both bank lenders and commercial real estate borrowers seem likely to experience some distress in the months ahead, the current down cycle also comes with many mitigating factors that were not there in the 2008-09 period. These include the fact that banks are still, as a group, better capitalized than they were in the years preceding GFC and that many real estate investors now carry lower leverage and have access to a more diverse array of potential lenders than they did during the previous credit crunch.
In fact, some figures that have been thrown around in support of the theory that both regional banks and their real estate borrowers are in deep trouble have simply been wrong, according to Moody’s. For example, it has been reported, incorrectly, that regional and local banks account for 65% to 80% of lending on commercial real estate. In reality, U.S. regional banks hold 13.8% of debt on income-producing properties, while banks overall account for 38.6% of commercial real estate lending, Moody’s found.
As such, commercial real estate debt accounts for just 7% to 10% of total debt in banks’ portfolios, noted Stephen Biggar, director of financial services research at Argus Research, who covers the big money banks. For smaller banks, who do carry more exposure to commercial real estate, that share could be closer to 20% to 30% of total debt, he added.
That’s where borrowers might see the biggest change in the months ahead. As regional banks become more concerned about depositors deciding withdraw their money, as they’ve done with Silicon Valley and Signature, the smaller regional banks might pull back on real estate transactions, according to Chad Littell, national director of capital markets analytics with real estate data firm CoStar. While the larger, national and international “money center” banks actually benefited from recent turbulence in the industry, the regional banks might put more scrutiny on new deals going forward.
“For the very best core assets in good locations banks are very competitive,” Littell said. “For regional banks, those more flush with deposits will show more willingness to lend than those with drawdowns on deposits.”
Case in point, Meridian Capital Group recently secured a $45 million, fixed-rate loan from Valley Bank for Crosby Hill Apartments, a newly constructed, 203-unit luxury apartment property in Wilmington, Delaware, on behalf of Buccini Pollin Group. Given that the bank felt comfortable with both the sponsor and the steady absorption rate at the project, the loan went through even before full stabilization, according to the mortgage brokers involved.
Only a limited number of small and mid-sized banks have risk characteristics similar the banks that have failed recently, according to market observers. Many (and there are thousands) still have the capacity to lend under moderately tighter underwriting standards, such as raising minimum debt service coverage thresholds and loan-to-value (LTV) ratios.
Last year, LTV ratios on commercial real estate loans originated by regional and local banks averaged about 66.4%, with the average loan size at about $7.6 million, according to research firm MSCI Real Assets. LTVs on loans originated by national banks were slightly lower, at 64.3%, with the average loan size of $14.3 million.
Still, a further slowdown on lending would occur in a market that already saw 7% fewer unique lenders being active in the commercial real estate marketplace in the fourth quarter of last year compared to 2021, MSCI reported. Apartment and industrial sectors saw even larger, double-digit declines in active lenders during that time period.
Overall, new loan originations for commercial and multifamily mortgages declined by 54% year-over-year and 23% quarter-over-quarter in the fourth quarter of 2022, the most recent period for which data is available from the Mortgage Bankers Association, an industry trade group. Originations by depositories in particular fell by 47% year-over-year.
At the same time, the 90-plus day delinquency rate on commercial real estate mortgages for banks and thrifts stood at 0.45%, above the delinquency rates for life insurance and agency lenders, but below the delinquency rate for CMBS shops.
Large regional banks have put in place measures to protect against defaults on the commercial real estate loans on their books, including requiring borrowers to deposit a certain amount of funds with them, according to Kevin Heal, chief compliance officer and senior analyst, financial services, at Argus Research who covers super-regional banks. They are still loaning money for commercial real estate, but now require “more skin in the game,” with 60-40% LTVs.
“This buffer provides significant value in the property if a foreclosure occurs,” he said.
Heal also noted that a lot more checks and balances have been put in place to scrutinize the fundamentals of the properties financed. In order to secure a loan on a retail asset, for example, it’s necessary to show that it features a major credit tenant, along the lines of Home Depot, for example.
In addition, nearly all banks have tried to break out of their exposure to office transactions due to the perceived risk around low occupancy numbers, according to Biggar. Exceptions include deals that feature both a client with whom the bank has a long-standing relationship and a high-quality credit tenant, but even those transactions will be put under the microscope.
One of the biggest area of concern for bank lenders right now are loans on properties with some occupancy or rent roll issues that are coming due in the next year or two, since those borrowers will likely have trouble refinancing at higher interest rates, Biggar said. The prime rate today is at 8.00% to 8.25%, he noted. “If they are struggling now, they will have trouble making ends meet at rates that are more than double [what they had been paying].”