Commercial real estate got some indirect bad news.
The Securities and Exchange Commission sent letter exchanges to several community or regional banks about potential exposure to CRE loans, as the Wall Street Journal reported.
The agency contacted Alerus Financial and the holding companies behind Mid Penn Bank, Ohio Valley Bank and MainStreet Bank. The letters were “to request more clarity in their disclosures around the potential consequences from the failures of First Republic Bank, Silicon Valley Bank and Signature Bank.”
The three banks were closed and put into receivership by the Federal Deposit Insurance Corporation. Certain long-term bond assets that the banks held lost a lot of value as the Federal Reserve drove interest up in an attempt to curb inflation. When interest rates rise, bond values at previous lower interest rates lose value. These bonds were classified by the banks as held-to-maturity, meaning they could be treated as keeping their face value. But concerned depositors pulled large amounts of money out of the banks. That forced the institutions to sell bonds, which then were marked to market, losing liquidity and pushing the banks toward insolvency.
CRE loans aren’t the same as bonds, but there are two ways they could lose value. One is that increased interest rates could put borrowers with loans coming to maturity into a position where they can’t get refinancing. The lending bank would at least have to modify the loan, which could affect depositor trust and willingness to leave their deposits in place. Or the borrower could outright default.
The other way they could suddenly lose value is if the valuation of the property dropped — something happening broadly across all asset types, as GlobeSt.com has reported. That could leave the loan underwater, increasing risk and leaving depositors concerned and, again, possibly pulling out money and threatening the bank’s liquidity and potentially solvency.
Small, mid-size, and regional banks were the originators of many of the existing CRE loans. Unlike consumer mortgages, the banks don’t sell off the loans, leaving them holding all the risk.
“The SEC is worried that some of the banks may not be disclosing as much of their risk or exposure as they should to their investors,” Kenneth Chin, a partner at law firm Kramer Levin Naftalis & Frankel, told the Journal.
The SEC asked the banks to provide a more specific breakdown of CRE loan portfolios by property type, geography, and other factors.
Although the SEC has only made direct requests of these banks, the thousands of other institutions could see this as a pressure they too could face. Banks might further restrict their lending activity in 2024, increasing scrutiny and tightening underwriting standards, like loan-to-value ratios, even more than has previously happened.