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Banks Have Another Reason To Scale Back CRE Lending

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The pressure that banks are feeling from CRE loans has become a regular observation by the Federal Reserve, Department of the Treasury, Federal Deposit Insurance Corporation, other regulators, economics, financial analysis, investors … pretty much everyone paying attention.

But there’s an odd twist according to a new analysis by economist and economic policy advisor Miguel Faria e Castro and senior research associate Samuel Jordan-Wood at the Federal Reserve Bank of St. Louis.

“Given the negative outlook on certain segments of CRE, one would expect that more-exposed banks have experienced worse market performances,” the two wrote. “We found that while CRE exposure has not mattered much for bank stock returns since the 2007-09 financial crisis, the correlation became significantly negative in 2023.”

The analysis started with an examination of the relationship between commercial real estate exposure as a share of total assets on one hand and total assets in billions of dollars, on a natural logarithm scale. Something immediately obvious is that the largest banks have a relatively small exposure in CRE loans as they represent 10% or less of their assets. But smaller to medium banks had high exposures, in some cases topping 60%.

They found that those banks with high exposure to CRE loans tended to have “relatively fewer liquid assets on their balance sheets, lower capital ratios (that is, more leverage), a larger share of their liabilities in the form of deposits, and a larger share of their assets in the form of loans.”

They then moved beyond a correlation analysis and used regression to look at the connection between CRE exposure and bank returns.

“From 2007 to 2008, the beta coefficient was statistically significant and negative, implying that banks with higher CRE exposure had lower stock market returns, all other variables equal,” they said. “Since the 2007-09 financial crisis affected not only residential real estate but also CRE, it is natural that more-exposed banks performed worse during that time. Our analysis reveals that while the correlation had been mostly inactive since then, it again became significantly negative in 2023.”

So, it seems to be another way banks are currently feeling negative effects from CRE exposure. Not just in concern over asset values and regulatory pressures, but in actual earnings.

 

Source:  GlobeSt.

 

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SEC Doubles Down On Bank CRE Loan Scrutiny

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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.

 

Source:  GlobeSt.

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Banks Expect To Tighten Standards For CRE Loans Even More

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A new Federal Reserve report noted that banks continue to get nervous overall and in particular about commercial real estate.

“Regarding loans to businesses, survey respondents reported, on balance, tighter standards and weaker demand for commercial and industrial (C&I) loans to firms of all sizes over the second quarter,” the report said. “Meanwhile, banks reported tighter standards and weaker demand for all commercial real estate (CRE) loan categories.”

The reactions to CRE lending was similar levels of tightening by large banks and others.

The July Senior Loan Officer Opinion Survey on Bank Lending Practices, or SLOOS, got responses from 66 domestic banks and 19 U.S. branches and agencies of foreign banks. Surveys went out on June 15, 2023, and were due back June 30, so all the data is more than a month old. It may be that conditions aren’t changing quickly enough to reduce the information’s meaning.

That said, according to the Federal Deposit Insurance Corporation (FDIC), as of the first quarter of 2023, there were 4,672 FDIC-insured institutions and 3,006 FDIC-supervised, so even though a concentration of the largest banks responding to the Fed’s survey might well be descriptive of that segment, the remainder isn’t nearly large enough for a comprehensive look at the banking industry.

The survey included two special sets of questions. One was about current lending standards compared to the midpoint of a range they have been in since 2005. The other question was bank expectations for changes in their standards in the second half of the year and the reasons for any change.

In the second quarter, “major net shares of banks” said they had tightened their standards on all categories of CRE loans. The same degrees of tightening were reported by large banks and other banks, though, again, without a representative sample, it’s impossible to say whether a majority of all banks were doing so.

Additionally, banks were largely reporting that there was weaker demand for all CRE loan categories. This was more pronounced in banks that were not the largest. Foreign-based banks reported similar responses on both questions.

According to the sample, standards tightening isn’t over. Major net shares of banks said they expect to tighten standards on construction and land development loans as well as on nonfarm, non-residential loans.

A moderate net share of banks said they would tighten standards on all residential real estate loan categories, including those that are GSE-eligible.

Also, the number of FDIC-insured and -supervised institutions in the first quarter of 2022 were 4,796 and 3,100 respectively. In the first quarter of 2021, there were 4,978 and 3,209. And in the first quarter of 2020, 5,116 and 3,303. While not a survey, the progression offers a partial different view of how the industry might be doing.

 

Source: GlobeSt.

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