Experts Say Connecting Bank Collapses to CRE Loans Isn’t So Simple

Getting hit in the head by an acorn and deciding that the sky is falling, as happened in the old folk tale, is objectively silly. And yet, seeing two banks collapse within a short period of each other and then wondering what might happen to CRE lending, especially after the experience of the global financial crisis, isn’t necessarily ridiculous. But it may not be reasonable.

“When examining the real cross-exposures of the sectors and structural differences between now and 15 years ago during the Global Financial Crisis (GFC), the conclusions are less sensationalistic and more nuanced than some headlines suggest, though both banking and CRE face challenges of a rapidly rising rate environment,” Moody’s Analytics said in a recent commentary.

As the firm noted, rising interest rates have already slowed transactions and pushed valuations downward. With rounds of refinancing coming, there will be some CRE loan defaults. For example, Chetrit Group, Columbia Property Trust, Brookfield, and Veritas Investments have all defaulted on loans this year. M&T Bank has said that 20% of its office loans are distressed.

But the specifics of how these dynamics might play out are complex. For example, many quote numbers that say 70% to 80% of CRE debt is held by small and regional banks. The distribution, and so vulnerability, is more complex.

“However, the 135 US regional banks (generally considered as those with about $10 billion to $160 billion in assets) hold just 13.8% of debt on income-producing properties,” says Moody’s. “The top 25 largest banks, which the Federal Reserve (Fed) considers “large”, hold 12.1%. The 829 community banks (with $1 billion to $10 billion of assets) hold 9.6%, and the remaining 3.2% is spread among the 3,726 very small local banks with less than $1 billion in assets.”

In other words, the U.S. CRE debt market is broader and deeper than often considered “and large banks and various non-bank lenders such as mortgage REITs, life insurance companies, and private bridge lenders could step in at fill a potential gap.”

Marcus & Millichap had recently made a similar point that the distribution of CRE loans among banks was more diverse than often mentioned. John Chang, senior vice president, national director research and advisory services, in a video for the company acknowledged that some loans will default, but most won’t.

At the same time, there are signs that bank stability is holding up. “Developments in the Fed lending programs over the last week have been credit positive and point to possible stabilization,” Moody’s Analytics said. “The Fed’s aggregate balance sheet contracted by $28 billion to $8.76 trillion, and the Fed lending to the banking sector declined $11 billion to $153 billion. On the asset side of the Fed’s balance sheet, the amount of outstanding discount window loans declined to $88 billion this week from $110 billion last week.”