In the months after three shocking bank failures, regional banks began a lending pullback of historic proportions — one that promises to continue.
In the second quarter, regional banks accounted for 25% of all new commercial real estate loans worth at least $2.5M, a 900-basis-point drop from the first quarter, according to datapublished Wednesday by capital markets research firm MSCI. It is by far the largest quarterly decline in market share for regional banks since MSCI began tracking the statistic in 2011.
"It was a record collapse of[regional banks'] market share," MSCI Chief Economist for Real Assets Jim Costellotold Bisnow.
Although the sharp rise in interest rates that began in mid-2022 has suppressed capital markets activity across the commercial real estate industry, the mass pullback among small and midsized banks had a separate and well-defined trigger: Silicon Valley Bank, Signature Bank and Silvergate Bankbeingclosed by regulators over a three-day period in mid-March.
"It's just the stigma effect of the smaller banks being painted as a source of calamity and risk," Costello said. "Others probably saw that and realized they had to tighten up what they’re doing."
Those three banks failed near the end of the first quarter, a period in which regional banks accounted for 34% of CRE loans, theirhighest share in MSCI's tracking history. Regional banks had a 23% market share in Q1 last year,and over a decade ago, in Q22012, they accounted for only 8% of CRE loans.
Anecdotally, regional banks have only becomemore conservative in the third quarter, which ends Saturday. The combination of shaken consumer confidence and apotential regulatory increase in capital reserve requirements looks likely toprevent regional banks from rejoining the party until interest rates begin coming down — whichdoesn't look likely in the near term.
Overall, Q2 saw a 31% increase in loan originations compared to Q1, a jump that can be partially but not completely explained by historical seasonality, according to MSCI's Mortgage Debt Intelligence database. Extensions, which havespiked acrossproperty types as a sharp rise inmaturities collides with high interest rates, aren't included in MSCI's data.
Because the initial shock of rising interest rates first hit the capital markets in the second half of last year, the Q2 boost in loansbrought the overall rate of originations close towhere it was in the half-decade before the pandemic began, as opposed to 2021 and the first half of 2022—a period that will likely only look more like an outlier as time goes by.
"Debt markets were way more liquid in 2021 and 2022, but it was almost excessively liquid," Costello said. "I put a low probability on the notion that we go back to how it was in 2021 and early 2022. There are people holding out for that. We’ll see."
Elsewhere in MSCI's report, over half of the $400B in loans the firm identified in February as maturing before the end of this yearare still outstanding. At least 40% of those outstanding loans are in CMBS packages, perhaps reflecting theirrelatively heavy reliance on office properties. With thevalue destruction in the sector caused by remote work, many borrowers may be having ahard time justifying a loan modification or extension.
In terms of aggregate dollar value, about the same amount of CMBS debt is scheduled to maturein the second half of this year as all of 2024, Costello said.
“It’s like a big chunk that has to be dealt with now, and then the relative size [of the CMBS pool] starts shrinking,” he said. “The big thing I’m worried about is all those office loans. We’ve got $350B maturing at the end of the year, so how does that work?”
Other property sectors continue to produce cash flow, which presents a compelling case for an extension until more debt capital becomes available, Costello said. Though nonbank lenders, including sellers and preferred equity, areexpected to take some of the market share ceded by regional banks, they aren't one-for-one replacements.
"If I’m a small bank in Missouri, I help small companies with their[commercial and industrial] loans to help them build small buildings," he said. "IfI pull back, it’s not as if debt funds can jump into those areas. Debt funds typically don’t have their own origination networks and tend to do bigger loans. So in those smaller markets, I’m worried to see what happens next."
