What This Means for Borrowers and the Economy
Recent bank closures have caused financial conditions to tighten as CRE lenders have begun to pull back from the market, and lending liquidity has been constrained. This has left people wondering what this means for the economy during the remainder of 2023.
The banking industry has undergone a significant transformation over the past few months, with the acquisition of First Republic Bank by JPMorgan Chase & Co. marking another milestone in the industry. This acquisition will lead to the consolidation of two of the top 25 commercial real estate lenders in the U.S. While this consolidation may not be significant, it points to a further thinning of the lender herd, which could complicate asset pricing due to changing competition to fill the debt portion of the capital stack.
Top 25 Commercial Property Lenders in the U.S.
- Wells Fargo
- JP Morgan
- Bank of America
- Morgan Stanley
- Walker and Dunlop
- Goldman Sachs
- Deutsche Bank
- Capital One
- PGIM Real Estate
- BMO Financial Services
- PNC Financial Services
- First Republic Bank
- Arbor Realty Trust
- Societe Generale
- Regions Bank
Impact of Consolidation
Consolidating two top lenders may reduce the number of lenders available to borrowers, rebalancing the composition of the U.S. lender field and reducing competition that could lead to higher rates and unfavorable terms for borrowers. This, in turn, could slow down the real estate industry and the overall economy.
Despite the potential negative impact of the consolidation on borrowers, the merger may lead to improved operational efficiency for the two banks, which could translate to better customer service. It is important to monitor the effects of this consolidation and the general trend of consolidation in the banking industry, as it could have far-reaching implications for the economy as a whole.
According to USA Today, Almost 200 banks are at risk of facing the same fate as Silicon Valley Bank.
With small and medium-sized banks accounting for 80 percent of commercial real estate credit, analysts predict that the situation will worsen soon. This recent volatility has caused many banks, especially regional ones, to pause production on new business. This pause will require many borrowers to deviate from their standard relationship lenders and find new sources of capital.
Some of these alternatives include:
Individuals who wish to manage their risk and grow their finances are finding private money loans to be a valuable option due to their capacity to offer short-term flexibility.
Debt Funds & Bridge Lenders
Debt funds are gaining popularity among investors due to their competitive interest rates and convenience. They provide an opportunity to generate high returns through leverage, particularly when investing in properties with the potential for value addition. Bridge lenders provide short-term financing solutions to borrowers who need quick access to funds for a variety of reasons, such as property acquisition, renovation, or refinancing. These lenders typically offer higher interest rates than traditional lenders and have a quicker turnaround time for loan approval and funding.
Fannie & Freddie
Fannie Mae and Freddie Mac are government-sponsored enterprises that play a significant role in the CRE multifamily sector. They are a major source of financing for commercial real estate and multifamily properties. They are particularly active in the multifamily sector, offering property owners and developers a range of loan products. These GSEs have always stayed steady in providing liquidity in the marketplace, although they can be more selective when the laws of supply/demand are in their favor.
Other Banks & Credit Unions
Yes, while many banks are on the sidelines- there are still some groups who are actively lending that do not share the same balance sheet risk concentration that many of the headline relevant banks share. These groups could offer new, local relationships at equal or maybe superior terms than previous relationship banks. All banks are starved for deposits at the moment. The ability to bring a new deposit relationship to a bank could yield a tremendous benefit to the investor with respect to flexibility and general terms.
Resilient U.S. Economy and the Credit Difference
The resilience demonstrated by our local economy at this stage in the economic cycle is remarkable. The chart shows that the combined size of the three recently closed banks is equal to all 25 banks that ceased operations in 2008. It is important to understand that there is a key difference between “then” and “present,” and that keyword is credit.
Credit, or lack thereof, led to a systematic failure of the U.S. Economic System. Between 2001-2007 banks, credit unions, and GSEs were lending based on hyper-aggressive credit parameters. These parameters would not be considered today. In 2008, when these banks failed- the system failed as property values fell into proportion with the “liquidity” bubble (provided by low credit qualities) that propped them up in the first place.
The Recent Bank Failures: Internal Risk Management and Yield Curve
This story is a bit different and not so systematic. These bank failures share a story of internal risk management and a failure to respect the yield curve. When cash is infused into the economy, and people start spending, people start making money and spending more; this spending leads to inflation which leads to more money, and people need a place to store their money. This is the first domino. People store their money in the form of bank deposits. Banks are responsible for protecting deposits but also making that money work on behalf of investments for their (and their depositors) benefits. These investments come in the form of loans, equity purchases, and the safest bet- bond purchases. In a low-interest rate environment (COVID), rates were low, and bond prices were high. Many of these banks purchased bonds as a “safe bet” but seemingly failed to have the risk management protocol to understand the “buy high, sell low” concept. This is precisely what happened.
What’s important to understand is the concentration of clients within these bank failures, SVB and First Republic (tech), and Signature Bank (cryptocurrency).
With the hits that both of these industries have taken recently (massive tech layoffs and large crypto discounts), these depositors need their cash! When banks need to serve their client’s needs, they are required to sell assets to liquidate those investments and provide cash. This exchange happens daily and, apart from periods of major volatility, occurs without a hitch- however what makes this scenario different is the “buy high, sell low” concept. Remember, the banks purchased bonds in a low-interest rate environment (when interest rates are low, bond prices are high), but when they need to sell/liquidate their positions in a high-interest rate environment in order to service a massive wave of depositor demands for their own cash (what is known as a bank run), you take an unrealized bank loss to a series of large realized bank losses. Here in lies the concept of the recent bank failures, and although massive, are seemingly (and hopefully) isolated to a select number of banks who failed to respect concentrations in both depositor relationships but mainly investments that are so heavily reliant on a yield curve that literally tells you the future.
Preventing Bank Failures
Keep in mind we’re not out of the woodwork yet, there’s actually a lot of wood to chop in the Fed’s flight for inflation, and every rate hike pushes the banks below closer to the edge and deepens their “unrealized losses,” all it would take is for any of these banks to suffer a bank run and they’re done. If you want to worry about liquidity, think about liquidity (or lack of it) when the largest US banks have shut their doors.
There’s no way to prevent what could happen, and there’s no way to assume that we’re in the clear. Rate hikes will continue to happen until inflation is cured; our hope is that the Fed is equipped to navigate these challenges and lead us out of these inflationary times.
During a volatile market, borrowers must understand how to find financing options to stay afloat. Further mergers or bank failures pose a significant threat to the health of the economy and the commercial real estate industry. However, those prepared to finance their investments through alternative options stand a better chance of surviving 2023.