Bank Failures Explained: Questions, Answers and How CRE Fits In

BANK FAILURES EXPLAINED

Questions, Answers and How CRE Fits In

APRIL 2023

Bank Failures Explained - Questions, Answers and How CRE Fits In

1

QUESTIONS

ELEVEN If my company is currently leasing space, what does the banking turmoil mean for me? What do I need to know? TWELVE I keep hearing that CRE is the next shoe to drop for the banking sector. Is it? THIRTEEN What should I be watching at this point, and where are we in this CRE credit cycle? FOURTEEN What about Credit Suisse? Is Europe’s banking system in a crisis?

SIX Are more regional banks going to fail? SEVEN When will we know if the banking crisis is over? What are you watching? EIGHT What has the government response been so far to the banking turmoil? NINE Are you concerned this is the Great Financial Crisis all over again? TEN Has your outlook for interest rates changed because of banking turmoil?

ONE Were the recent U.S. bank failures unique cases or are they symptomatic of larger problems facing the financial system? TWO How common are bank failures? THREE Given the banking turmoil, have recession odds risen? FOUR How important are community and regional banks to CRE? FIVE How will the lending environment shift because of the bank issues?

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION ONE

Here’s the but: SVB was not the only bank to experience a surge in deposit growth. In fact, the entire banking system experienced unusual levels of deposit growth due to COVID-related stimulus. Recall that the U.S. passed a total amount of stimulus equating to 25% of pre-COVID nominal GDP, and many individuals and businesses parked it in banks. Total deposits grew by 35% from February 2020 to the peak in April 2022. These aren’t SVB levels of deposit growth, but it is the strongest rate of growth since the Federal Reserve began tracking the data in early 1970s. And what did these banks do with their surging deposits? They did what SVB did, but to a much lesser extent; they loaded up on long-term Treasuries and Agency securities in a low interest rate environment. (Compare SVB with 55% of its assets in these securities versus the broader banking system which is closer to 19%.) As interest rates have risen in the last year, the underlying value of those securities has fallen. Thus, there is still some concern with liquidity issues at other banks, but there is also a big “if” attached here. If, for whatever reason, a bank needs to quickly raise capital, they could run into a similar problem; they may be forced to sell Treasuries and/or MBS securities at a loss – which could lead to liquidity or solvency issues, or even another panic. This is one of the reasons policymakers (the Federal Reserve, Treasury and FDIC) responded so aggressively. Here’s the bottom line: This looks more idiosyncratic than it does systemic. There will certainly be other issues in the banking system, but they should not be nearly as problematic, partly because those three banks were unique, and partly because of the strong and fast government response.

The three banks that grabbed the headlines over recent months all had idiosyncratic factors that led to their failure. Here we highlight a few of the unique aspects: • In the case of Silvergate , reacting to a stunning rate of deposit outflows (deposits went from $11.9 billion in September 2022 to $3.8 billion by the end of the year), it drew advances from the FHLB system and then ultimately sold securities at a $718 million loss, wiping out its capital, and announced it would shut down its banking unit. This was not a very large bank, and this failure did not really ‘create the panic.’ Its failure was not noteworthy until SVB, and its resolution does not involve the FDIC. • SVB recorded explosive growth in their deposits during the pandemic (roughly 200% compared to 35% for all commercial banks). A preposterously high percentage of those deposits were uninsured by the FDIC because the account balances of their clients—largely tech and VC firms—were much greater than the $250,000 FDIC threshold. At SVB, 94% of deposits were uninsured versus about 45% for the rest of the banking industry. So, SVB’s heavy concentration of clients within a narrow set of sectors and in uninsured deposits were both atypical. Indeed, SVB was a unique case. Lastly, SVB had unusually high levels of securities on the asset side relative to the broader banking system—an outcome of very poor risk management. SVB is not a good representation of the broader banking sector, but given its size, and following the events with Silvergate, markets started to panic. • Another tale involving heavy exposure to cryptocurrency and other digital assets is that of Signature Bank . Signature also had 89% of deposits above the FDIC threshold, and after the panic created by SVB’s failure, it did not have enough time to come up with liquidity to satisfy depositor withdrawals. Regulators stepped in and put the bank in receivership. Signature was unusual the way Silvergate was—concentration in crypto and high dependence on uninsured depositors.

Were the recent U.S. bank failures unique cases or are they symptomatic of larger problems facing the financial system?

ANSWER

Unique cases, with a but…

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION TWO

How common are bank failures?

ANSWER

Very common. Since 1934, there have only been five years in which a single bank hasn’t failed: 2005, 2006, 2018, 2021 and 2022. It would be more unusual if there were no bank failures in any given year, but you typically don’t hear about them. This is because the FDIC and regulators have a process for an orderly resolution, such that the failing bank could be acquired by another bank, or if that is unable to be brokered, the FDIC ensures that (insured) deposits are made whole, and the FDIC then sells the failed banks’ assets. It’s not headline news most of the time. Bank failures aren’t rare, but bank runs are . What we observed with Silvergate, Silicon Valley Bank (SVB) and Signature falls into the “bank run” category which is when bank customers flock to banks and make withdrawals because of the loss of confidence in the bank. Moreover, the recent bank failures had a few unusual features. First, in the cases of Silvergate and Signature, underlying losses in the value of cryptocurrency served to act as a deposit outflow prior to outright withdrawals happening. Given how new cryptocurrencies are, there have not been episodes quite like those before. Second, all three occurred at a time when the U.S. economy was still creating lots of jobs and unemployment remained historically low. There are many other aspects about the recent bank failures that are quite different relative to historical analogues, which we will discuss within this larger FAQ document.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION THREE

If we look at probabilities from implied Treasury yield curves (10-year versus the 3-month), the probability of recession was 67% pre-SVB and it rose to and has stayed at 80% since April 4. We have not changed our baseline view despite these recent events. Our baseline was already calling for a modest recession to occur in 2023 and we knew that adjusting to higher interest rates would result in tighter credit and greater volatility. For now, we remain confident in our baseline but would emphasize that risks have skewed further to the downside given recent events.

Recession risks were already high and lending markets were already tightening for the better part of a year leading up to the panic. The bank turmoil is still fairly new news and most forecasters haven’t had a chance to re-run their models. But it’s clear this episode resulted in a further tightening of credit conditions—which impacts the availability of credit to businesses, particularly for small and medium-sized businesses (who rely on community and regional banks). This is one primary channel through which monetary policy impacts the real economy, in addition to expectations and sentiment. Probability of Recession

Given the banking turmoil, have recession odds risen?

PROBABILITY OF RECESSION

ANSWER

100

In our view, yes – but only slightly.

90

80

70

60

50

40

30

20

10

0

Apr-71

Apr-13

Apr-16

Apr-19

Apr-10

Apr-01

Apr-77

Apr-22

Apr-83

Apr-62

Apr-92

Apr-65

Apr-95

Apr-74

Apr-68

Apr-86

Apr-89

Apr-98

Apr-07

Apr-80

Apr-04

Recession

Implied Probability (Based on 10-Year/3-Month, %)

Source: Moody’s Analytics, NBER Source: Moody’s Analytics, NBER

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Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION FOUR

Let us take a step back for a moment and lay out the big picture of the CRE universe of lending. Banks typically account for about 42% of lending (the average share from 2017 to 2022), followed by the Agencies/GSEs (23%), CMBS (13%), financial firms (11%), insurance companies (9%) and other (3%). Thus, banks are the largest share by far. CRE Lending by Source Banks typically provide around 40% to 45% of total financing CRE LENDING BY SOURCE Banks typically provide around 40% to 45% of total financing

How important are community and regional banks to CRE?

50%

$1,000

ANSWER

40%

$800

Important.

30%

$600

20%

$400

Billions

10%

$200

0%

$0

2011

2017

2012

2021

2015

2013

2018

2016

2019

2014

2010

2022

2020

Banks Agency CMBS Financial

Insurance Private Other/Unknown Bank Share as a % of Total (RHS)

Source: Source: MSCI Real Capital Analytics

Source: MSCI Real Capital Analytics

/ 0

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Bank Failures Explained - Questions, Answers and How CRE Fits In

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How important are community and regional banks to CRE? QUESTION FOUR

Community and regional banks are the lifeblood of the CRE lending landscape among the banks, which collectively have $2.8 trillion in loans associated with our concept of “CRE.” 1 In our industry, many use these bank-size designations colloquially, but the Fed and FDIC mean specific things when they talk about ‘community or regional banks,’ so we’ve clarified the asset sizes associated with those terms. Big banks (above $250 billion in assets) account for about 55% of total assets in the banking system, 45% of all lending, 27% of all multifamily lending, 20% of all nonfarm nonresidential lending and 18% of all ADC lending. 2 Big banks account for 28% of unused CRE credit lines. Super-regional banks ($100 billion to $250 billion in assets) account for 15% of total assets in the banking system, 17% of all lending, 14% of all multifamily lending, 10% of all nonfarm nonresidential lending and 9% of all ADC lending. Super-regional banks account for 10% of unused CRE credit lines. Regional banks ($10 billion to $100 billion in assets) account for 15% of total assets in the banking system, 19% of all lending, 32% of all multifamily lending, 32% of all nonfarm nonresidential lending and 34% of all ADC lending. Regional banks account for 35% of unused CRE credit lines.

Community banks (under $10 billion in assets) account for 15% of total assets in the banking system, 19% of all lending, 27% of all multifamily lending, 39% of all nonfarm nonresidential lending and 39% of all ADC lending. Community banks account for 27% of unused CRE credit lines. The point here is that the smaller banks that comprise a relatively smaller share of total assets also are responsible for a majority of multifamily, nonfarm nonresidential and ADC lending (within the banking sector). This was true before the pandemic, and it’s true now. Thus, it always matters how smaller banks behave with respect to CRE lending, risk appetite, underwriting standards and their own risk management. It will also matter if these banks experience their own panics/bank runs, even though we do not think that is likely. The smaller the bank, the less reliant on securities with interest rate risk and the greater the share of deposits that are guaranteed. However, the smaller the bank, the greater the concentration of CRE credit risk, too.

Important. ANSWER

1 Note that the Fed and FDIC refer to CRE as the sum of nonfarm nonresidential, multifamily, ADC and farm lending. We exclude farm-related lending from our nomenclature . Specific language is used to ensure there is no confusion about the underlying statistics being cited and we adjust “CRE” totals to exclude farm loans. 2 Based on data from the FDIC as for Q4 2022. ADC is acquisition, development and construction.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION FIVE

How will the lending environment shift because of the bank issues?

ANSWER

It will get tighter, but it was already tight. In the second half of 2022, nearly every CRE lending group began to pull back (i.e., most banks, CMBS, life companies, etc.). Given that inflation remained stubbornly elevated, the Fed was raising rates and recession risks were going higher. Pricing risk became increasingly difficult, so lenders largely headed to the sidelines. That isn’t to say the debt markets weren’t functioning, but they were largely focused on high quality assets, which to a large extent overlapped with favored property types like industrial and multifamily—although some rebound in the experiential/services economy helped retail and hotel to rebound on a market share basis. It’s impossible to have a counterfactual of what CRE lending would look like without SVB, but we know that lending standards by banks had tightened dramatically in the run up (no pun intended!)

to recent issues. How can we gauge marginal changes in how risk is being perceived for CRE borrowers? Well, for risk-adjacent Baa corporate bonds, the spread over the 10-year Treasury note jumped from 184 bps on March 9 to 226 bps (the latest peak) on March 23. Since then, it’s come in to around 210 bps. So, let’s call the risk spread out by about 25 to 30 bps post-SVB. Corporate bond spreads are only one piece of the puzzle. Going forward, we will be carefully monitoring many aspects of the debt markets, including CMBS since this was an important source of shorter term, floating rate loans leading up to this year and with higher exposure to the office sector, and because CMBS spreads have behaved differently in recent weeks compared to corporate bonds. On the banking side, the Q1 2023 results from the Fed’s Senior Loan Officer Opinion Survey will also be informative in gauging debt availability.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION SIX

As mentioned in another answer, in any given year, we should probably expect at least a few banks to fail. That said, we don’t think most banks will follow the fates of Silvergate, SVB and Signature. Most banks have a lower reliance on uninsured deposits. Although there is not system-wide data on depositor concentration, several of the banks under stress post-SVB released statements about their depositor reliance in order to calm fears about ties to tech/VC and crypto, and to demonstrate the diversity of their depositor base (e.g., First Republic). Most banks have deposits across an array of sectors and individuals, meaning that the likelihood that all of them need the entirety of their money at the same time is lower than what it was for the recently failed banks. Capital ratios are generally in a healthy territory: tier 1 and tier 2 assets (as a share of risk-weighted assets) range from 14% to 19% across bank sizes with the smallest banks (community banks) at the top end of that range (more capitalized). Other capital ratios are also in good condition. Further, and very importantly, the exposure of banks to the kinds of assets that took SVB down are vastly more limited—with smaller banks (the more important for CRE) less exposed. The translation of this is that the smaller the bank, the less exposed to unrealized losses on Treasury and Agency securities. And when viewed relative to capital, these exposures are actually quite limited, particularly those associated with held-to-maturity assets. Yes, some banks have large exposures, but the average bank—especially the average community bank—does not. The reality is that the system is as well-capitalized as it’s been in 40 years with diversified lending and depositors, but no bank can withstand a panic and a run. That is counter to the entire business model. So confidence is key, and this is why regulators responded so swiftly and strongly.

Are more regional banks going to fail?

ANSWER

Hard to say, but most regional banks should not face the same issues as Silvergate, SVB and Signature. However, no bank, no matter how well-managed, can survive a run on deposits.

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Bank Failures Explained - Questions, Answers and How CRE Fits In

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Unrealized Losses on Securities Relative exposure by bank size

QUESTION SIX

UNREALIZED LOSSES ON SECURITIES Relative exposure by bank size

Are more regional banks going to fail?

Nominal Unrealized Losses (Billions) N i al Unrealized Losses (Billions)

Nominal Unrealized Losses Relative to Capital No i l Unrealized Losses Relative to Capital

$300

$25

2.0%

25%

$250

ANSWER

1.6%

20%

$20

Hard to say, but most regional banks should not face the same issues as Silvergate, SVB and Signature. However, no bank, no matter how well-managed, can survive a run on deposits.

$200

1.2%

15%

$15

$150

0.8%

10%

$10

$100

0.4%

5%

$5

$50

0.0%

0%

$0

$0

<$10 billion $10-$100 billion

$100-$250bn >$250bn+

<$10 billion $10-$100 billion

$100-$250bn >$250bn+

Unrealized Loss % Equity HTM Unrealized Losses % of Equity (RHS) HTM Unrealized Losses % of Equity (RHS) Unrealized Loss % Equity

Book Value Minus Fair Value (Unrealized Loss) Average Unrealized Loss (RHS) Book Value Minus Fair Value (Unrealized Loss) Average Unrealized Loss (RHS)

Source: FDIC, Moody’s Analytics

/ 1

Source: FDIC, Moody’s Analytics

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION SEVEN

Deposit flows: If deposits keep flowing out, that’s a sign of building trouble and a loss of confidence. Every Friday the Fed publishes the H.8 release which includes weekly updates on the assets and liabilities of banks—you guessed it, deposits! Deposits were at $17.7 trillion pre-SVB (March 1) versus $17.3 trillion (April 5). A few key notes: Deposits had peaked in April 2022 and were gradually declining as money market rates exceeded savings rates—the pace of decline was manageable until a panic. Most of this was unnoticed and concentrated in large banks. However, since SVB, there has been a shift in deposits towards larger banks from smaller banks, but this appears to have stabilized. We will be monitoring weekly for this. Bank lending: In the same H.8 release, the Fed publishes weekly lending volumes by commercial banks. In the two weeks ending on March 29, bank data showed a pull back on multifamily, ADC and nonfarm nonresidential lending by $35 billion, the most significant two-week decline in the series. In the week ending April 5, such lending increased by $334 million (a reversal). It is unclear if the sharp pullback reported earlier was due to the transfer of SVB and Signature’s assets to receivership at the FDIC. Given the attention on CRE and credit risk now, versus the initial panic, it will be very important to watch this data to really understand how banks are navigating incoming maturities, and to what extent bank credit is diminishing. Fed balances: A sizable increase in the provision of credit by the Fed would signal that ongoing liquidity issues are not resolving. Every Thursday, the Fed publishes the H.4 release which includes information about factors that affect reserve balances—this includes draws at the discount window (primary credit) and the new BTFP, as well as many other levers the Fed uses to provide liquidity to banks. Since March 1, a few line items have moved a lot:

• Primary credit: up from $4.8 billion on March 8 to $68 billion on April 12, but down by a significant $85 billion from its peak on March 15 ($152 billion). It appears some of the initial volumes borrowed shifted to BTFP (which was not operational the full week before March 15). • BTFP: up from $0 (not existing) to $72 billion. BTFP borrowing peaked the week of April 5 at $79 billion and receded in the most recent week of data. • USD swap lines to foreign central banks: surged by $60 billion after the acquisition of Credit Suisse but declined in each of the weeks following. This is a sign other central banks needed help getting dollars, but that need is dissipating. Currently, this volume stands at $30 billion, half of its original amount. • “Other Credit Extensions”: the line item that contains loans to the FDIC bridge banks was up from $0 on March 8 to $180 billion on March 22 with the biggest jump the week of the bank failures (it jumped by $143 billion that week and by $37 billion the following week). In the latest week available, this line was down from its $180 billion peak, at $173 billion. Jobless claims: Job losses and quickly falling inflation is the narrow path for the Fed to pivot and begin cutting rates ahead of 2024. Every Thursday, the Employment & Training Administration releases a count of initial claims for unemployment insurance. A rapid increase in these numbers within a three-month period is typically a sign that a recession is starting, and that job losses are happening (and should be reflected in the Bureau of Labor Statistics numbers shortly thereafter). Any rapid changes from week to week will be key to note.

When will we know if the banking crisis is over? What are you watching?

ANSWER

We wouldn’t call three banks out of nearly 5,000 a crisis, but here’s what we are watching.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION EIGHT

Policymakers essentially did five big things within days of the SVB failure on March 10: 1. On Sunday, March 12, the Secretary of the Treasury, upon the unanimous recommendation of the boards of the Federal Reserve and the FDIC, approved systemic risk exceptions for the failures of SVB and Signature. This enabled the FDIC to guarantee all deposits of both banks (SVB and Signature). This action sent signals to the market and consumers that all depositors should have confidence in their bank and could rest assured that even if you deposit more than $250,000 in a bank, for now, those dollars were safe. The goal was to stymy the panic. 2. The Federal Reserve created the Bank Term Funding Program (BTFP) on Sunday March 12. This facility is backstopped by $25 billion from the Treasury’s Exchange Stabilization Fund. Banks can exchange select securities—namely Treasuries, Agency securities and Agency-backed MBS—at par value instead of at fair value (which include unrealized losses tied to the effects of higher interest rates) for up to one year—thereby offering liquidity to banks. (If banks use the primary credit window, collateral could include other asset types, like other non-Agency loans, but they are valued at fair value and such exchanges last only 90 days.) Succinctly, the BTFP provides banks with access to emergency funds to meet the liquidity needs of their depositors. By providing relatively short-term loans, the program aims to help provide institutions with liquidity thereby resolidifying market confidence and averting more extensive deposit outflow or “bank runs.”

3. On March 15, the Fed tweaked discount window operations in two ways: 1) narrowing the spread of the primary credit rate relative to the general overnight interest rate, and 2) allowing borrowers to get credit for as long as 90 days. The discount window is a Federal Reserve lending facility to depository institutions, the mechanism through which the Fed is the ‘lender of last resort.’ It provides ready access to funding to help banks manage their liquidity risks efficiently and provides funding during times of market stress, for example when customers and businesses start withdrawing rapidly. Unlike the BTFP though, discount window lending applies a haircut to collateral being pledged. 4. On March 16, the Treasury helped coordinate $30 billion of deposit injections from 11 big banks to First Republic (which was suffering from deposit outflows at the time). This included $5 billion of uninsured deposits from JP Morgan, Bank of America, Wells Fargo and Citigroup as well as $2.5 billion from Goldman Sachs and Morgan Stanley. An additional five banks each deposited $1 billion. All of these were uninsured and intended to signal confidence in the other large regional banks and hence calm some of the panic. 5. On March 16, in its release of Federal Reserve’s report on factors affecting reserve balances (the so-called H.4 release), it disclosed lending of $143 billion to bridge banks set up by the FDIC (footnote 7 under Table 1), presumably to resolve SVB and Signature. These Fed loans were backed by FDIC collateral and repayment guarantees. Since then, the balance of these loans has increased to $173 billion.

What has the government response been so far to the banking turmoil?

ANSWER

Massive response, and fast.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION NINE

The financial system is much stronger today versus before and during the GFC. In fact, in response to the GFC, the banking system underwent massive reforms to prevent a repeat. Banks are now more capitalized and widely considered better protected for downside scenarios. For example, the 2022 Dodd Frank stress test results revealed that large banks—specifically those with systemic importance—have sufficient capital to absorb more than $600 billion in losses (of which $75.4 billion are tied to CRE). Aggregate capital ratios in 2022 all exceeded the minimum regulatory thresholds at their trough. (We acknowledge, however, that the Fed has only just added sharply higher interest rates into its 2023 stress tests whose results are due in June this year. Regardless, last year’s tests put significant pressure on banks via credit default channels, which is increasingly where there will be focus during the coming year.) Policymakers responded much more quickly today versus during the GFC. SVB collapsed on March 10, and just two days later, regulators acted. They collectively chose to invoke systemic importance clauses, enabling all deposits to be guaranteed. The Treasury and Federal Reserve set up an emergency credit facility for banks facing liquidity issues, providing some initial confidence to the markets. This historic program is likely to redefine how banks are equipped to confront and tackle liquidity crises brought on by interest rate risk. Further, the FDIC is conducting normal, orderly liquidation operations, as it does during any bank failure. Actions during the GFC, in contrast, were largely reactive versus proactive. The Fed provided liquidity to the markets on-demand but with limitations (such as requiring a

high level of credit quality for collateral that financial institutions had to provide to get liquidity). The Fed could not set up credit facilities to address toxic assets without funds from Congress, who took until October 2008 to approve the Emergency Economic Stabilization Act of 2008, which included $700 billion for the Trouble Assets Relief Program (TARP). TARP, in turn, allowed the Fed to create an alphabet soup of facilities to absorb toxic assets from the financial system by providing it with funding to cover losses. Those tough lessons learned showed that fast and decisive action is likely a better approach. This benefitted the U.S. economy and financial system during the pandemic and at present, when regulators did not hesitate to act. There are ongoing concerns around banks’ unrealized losses that stem from interest rate risk on securities on their balance sheets (which is not linked to performance of their credit or outstanding loan portfolios). Today, banks have about 19% of assets in the form of these securities. About half of those are held as “available for sale” (in which case, unrealized losses do flow through and impact capital ratios) and about half are being held as “held-to-maturity” (which do not impact capital ratios and are thus, of more concern). The intent, though, with HTM assets is that banks hold them until they mature. Only if they sell them does a loss result, and that is only if a bank did not have hedging in place to offset that loss (which most banks actually do). If they hold them to maturity, they get every dollar promised in the underlying security. If deposit outflows are gradual and/or a panic is avoided, there is no need to sell these securities at a discounted price. In contrast, during the GFC, banks were facing

Are you concerned this is the Great Financial Crisis all over again?

ANSWER

No, this is not that.

CONTINUED >>

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION NINE

ANSWER

Are you concerned this is the Great Financial Crisis all over again?

No, this is not that.

A credit crisis in the largest and most important debt market—that of single-family residential mortgages. These are two very different challenges, with very different underlying causes. While a credit cycle is underway and in its early stages, the recent failures of the three aforementioned banks have nothing to do with credit and instead relate to the ramifications of a rising-rate environment and the resulting impact on bond and securities values, as well as their over-reliance on uninsured deposits and specific sectors. The size of the problem today is much smaller. In the run up to the GFC, household mortgage debt represented 63% of GDP and vacancy was higher (reaching ~10% for single-family rental, SFR). Today, household mortgage debt is closer to 45% of GDP and vacant housing is low at 5.4% for SFR. CRE-related debt reached nearly 25% of GDP at the height of the GFC but is now at 17% as of Q4 2022, with the additional backdrop that vacancy rates are generally lower and expected to remain lower than GFC-peak-levels, except for office which set a new peak vacancy rate record in Q1 2023. Further, while SVB and Signature were sizable banks, they pale in comparison to Lehman Brothers, Bear Stearns, Merrill Lynch, Washington Mutual, Wachovia and AIG. Derivatives, which contributed to the panic during the GFC and a general distrust of counterparties, underwent reforms like the bank sector and are now registered with clearing houses. Generally most measures of derivatives activity are in much healthier territory than pre-GFC.

QUESTION TEN

ANSWER

Has your outlook for interest rates changed because of banking turmoil?

Not Really.

Forecasting interest rates is not for the faint of heart during normal times let alone during periods of elevated uncertainty. Since the pandemic, it feels as though we’re operating in an environment where uncertainty is higher (certainly than it was in the last cycle). However, recent issues in the bank sector and the ensuing volatility in rates has not fundamentally altered our view of where they are headed (yet), though we note our outlook here is tied to important incoming data. We believe the Fed will remain focused on its inflation-fighting mandate, and we have one more 25-bps hike penciled in, before they hold through the rest of the year. Inflation has remained stubborn and the Fed’s measures of supercore/core services inflation has been reaccelerating in recent months. Ultimately, the convergence of tighter credit and slowing growth (and ultimately a mild recession) will help bring inflation down (on top of other factors that will cause it to slow), thereby allowing the Fed to pivot by spring of 2024. When this happens, we believe bond markets will price a new growth cycle, causing the yield curve to un-invert, thereby pushing up rates at the long end of the curve. Over our forecast, we call for relative spreads between the fed funds rate, the 10-year Treasury and the Baa corporate bond to normalize, putting us in a camp that believes H1 2024 will be when rates are highest. We will learn a lot in the coming months—about inflation, labor market strength and financial stress—and we will update our views as and when needed.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION ELEVEN

If my company is currently leasing space, what does the banking turmoil mean for me? What do I need to know?

ANSWER

There are a few key things to consider. • With the economy slowing and a mild recession as our baseline, we already expected most property types to shift towards a tenant-friendlier environment. Landlords will be looking to fill space amidst broad softening in momentum and the latest volatility will likely give tenants, on average, even more leverage. • That said, don’t expect all tenants to be treated equally. It usually is the case that tenants want information about a landlord’s financials and vice versa. For high quality tenants, you just got more leverage. For tenants with a shorter track record or who don’t have pristine credit, it may be harder to qualify for a lease. Landlords will want to ensure the viability of the lease commitment. • Due diligence on a landlord’s finances lets tenants be better educated about the propensity of a given owner to invest in their asset, absorb increases in operating costs (that they shoulder) and to weather the ongoing headwinds associated with the interest rate environment. Tenants should be well informed about these matters.

• For companies who have leased space in ongoing construction, the good news is that most development is considered to be attractive on a risk-adjusted basis. Even if banks pull back from lending here, the reality is that other lender groups have been willing to step in. Most new CRE product outperforms the broader market. There could be bumps in the road though, if a developer cannot secure financing and a project stalls. • Some companies had deposits and/or letters of credit at the failed banks. On deposits, even if a bank fails, the FDIC has a process to handle the resolution and that typically means your bank name will change, but within days of a failure, deposits are available. Recently, all deposits were made whole but that is not a guarantee moving forward. On LOCs, companies should be prepared to replace LOCs quickly in anticipation of demand letters from landlords. These unique circumstances apply to those who were clients of a failed bank. Knowing what to anticipate ‘in case’ is helpful but we don’t think many more banks will go down like the three we’ve been discussing in this document.

Bank Failures Explained - Questions, Answers and How CRE Fits In

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QUESTION TWELVE

Any weakness in the CRE sector will pose an added challenge for lenders writ large and banks, particularly those banks whose loan portfolios comprise an outsized share of their assets and whose portfolios are particularly exposed to certain challenged sectors (office and to some extent legacy retail). This is going to unfold over the course of the next several years, particularly as lenders are faced with the decision to amend/modify/extend maturing loans, and as owners are faced with a confluence of factors impacting their asset values and property cash flows. But this is not something that we (and other experts) currently believe is going to cause a systemic banking system failure across the board. This is not to say that we are minimizing, placating, or glossing over the issue – it will be painful for some borrowers and lenders, and it will create dislocations in the marketplace whereby certain equity or debt sources may need to step in to provide solutions to underwater owners, to defaulting loans or to distressed asset sales. It is to say that exposures are concentrated and the impacts “of distress” are not going to be uniform across the industry. It’s worth highlighting what sorts of factors could cause isolated and potentially more widespread loan (or credit) stress for the banking sector. It’s likely to be one or a combination of the following: an oncoming loan maturity which requires a capital infusion, a diminution

of underlying asset value in response to rising cap rate environment (underwater situations) or deteriorating cash flows that undermine loan performance status. This is very important context to keep in mind because any forward looking (and backward looking for that matter) context is going to involve some benchmark or assumption of how current conditions look in relation to maturity, value and property income. For example, if we’re talking about the oncoming wall of maturities and what that means for potential forced loan maturity risk, we need to understand how today’s conditions differ from past cycles. That said, let’s keep it in perspective. Banks account for about 40 to 45% of lending in any given year (based on origination data from MSCI Real Capital Analytics). In terms of upcoming maturities in 2023 and 2024, MSCI Real Capital Analytics data show that (domestic) banks account for approximately 29% to 34%, or $115 billion and $171 billion, of the total $394 billion and $501 billion maturing in those years, respectively. Further, with respect to concerns about office, of the (domestic) bank loans maturing over these two years, only 28% to 34% or $28 billion and $40 billion are office (of the $98 billion and $117 billion maturing across office overall, in 2023 and 2024 respectively). When viewed in this light, relative to the size of their outstanding portfolios and capital on hand, we should be cautious when predicting how systemic these issues are for banks.

I keep hearing that CRE is the next shoe to drop for the banking sector. Is it?

ANSWER

Any weakness in the CRE sector will pose challenges for lenders. Relative exposure matters. So do asset-level dynamics. In other words, citing the infamous show VEEP, “it’s nuanced.”

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What should I be watching at this point, and where are we in this CRE credit cycle? QUESTION THIRTEEN It’s the early days, but history has taught us that conditions can change relatively quickly so it’s good to have a pulse on things even if it doesn’t feel as if anything is sounding an alarm bell just yet (in the data, that is). ANSWER

Remember that we should be evaluating all indicators against the form of potential stress or distress it’s linked to (whether that be maturity, value diminution or cash flow). So, here are a few indicators or real-time themes that we’re watching closely as we monitor broader CRE loan health: • CMBS loan performance data can provide a real-time benchmark of loan performance across the industry at large. U.S. CMBS delinquency rates (owners that are 30 days past due on loan payment) remain very low, at just 2.1% as of April 2023 (3.0% in office). Yes, they are going up, but are still very low. For context, delinquency rates reached 10% during the GFC. For every ~3 office buildings you see in the headlines as distressed, there are 97 others that you don’t see that are cash flow positive with no current loan-related issues. • We can also evaluate cross-segment CRE debt financing against loan performance status. 3 Despite accounting for just 14% of total financing, CMBS accounts for a significant portion of troubled loans. Specifically, $88.5 billion (62%) of the total loan volume that is REO (real estate owned) by the lender, that is troubled or potentially troubled, is in the form of CMBS from 2017-2022. In total, $143 billion of loans were categorized as troubled or potentially troubled during this period. • We can monitor prevailing underwriting standards. In general, property owners are entering this downcycle from a position of strength. DSCRs are very healthy, 2.5 is the average over the 2017

2022 period, so owners have more than double the NOI needed to pay their monthly mortgage. 4 Loan matures, pay off the balance, and you’re fine. Loan matures, refinance even at a higher interest rate, and you should be okay, still cash flow positive. Especially considering that many maturities were originated in 2013-2018 when interest rates were only 120 bps lower than they are today (versus more recent vintages that were originated when Treasury rates were at record lows). It’s primarily the lower quality assets that are more exposed to weakening NOI (think low quality office) that will face the greatest challenges. • We can monitor banks’ forward-looking expectations for the credit market, proxied by loan loss reserves (LLRs) as a leading indicator or barometer for potential distress (or credit stress) because it reflects a bank’s assessment of the credit risk associated with its loan portfolio. Banks are required by their respective regulatory agencies to maintain adequate loan loss reserves to cover potential credit losses or defaults. Increasing loan loss reserves can thus signal that a bank is anticipating higher defaults of delinquencies in its loan portfolio. When a bank determines that its existing loan loss reserves are insufficient to cover potential credit losses (across the entirety of its loan portfolio, not just CRE), it may need to increase its reserves. While each bank carries varying levels of reserves depending on their profiles and unique risk profiles, LLR rates have compressed from their post-pandemic highs and are currently hovering around their historic low point of 1.6%.

3 Utilizing data sourced from MSCI Real Capital Analytics. 4 This is referencing CMBS DSCRs as sourced from Trepp and JP Morgan.

CONTINUED >>

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Loan Loss Reserves Loan loss reserves as percent of total loans LOAN LOSS RESERVES n loss reserves as percent of total loans

What should I be watching at this point, and where are we in this CRE credit cycle? QUESTION THIRTEEN It’s the early days, but history has taught us that conditions can change relatively quickly so it’s good to have a pulse on things even if it doesn’t feel as if anything is sounding an alarm bell just yet (in the data, that is). ANSWER

5.0

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0

1991

2011

1997

1992

1995

1993

2017

2012

2021

1998

2015

2013

1996

1999

2018

2016

2019

1994

2014

2001

2010

2000 2022 All Institutions Bank Holding Companies >$750B Bank Holding Companies $50B-$750B Banks and Bank Holding Companies <$50B 2002 2003 2004 2005 2006 2007 2008 2009 2020

Sources: Federal Reserve Bank of New York Sources: Federal Reserve Bank of New York

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QUESTION FOURTEEN

What about Credit Suisse? Is Europe’s banking system in a crisis?

ANSWER

No, definitely not.

Credit Suisse should not be seen as a domino falling in reaction to what has happened in the U.S., nor should it be viewed as a suggestion that a systemic sequence of failures is expected. For contextual background, Credit Suisse has been plagued by a series of scandals and financial losses unique to its own history.

Read more about our views on Europe’s banks here.

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About Cushman & Wakefield

Cushman & Wakefield (NYSE: CWK) is a leading global real estate services firm that delivers exceptional value for real estate occupiers and owners. Cushman & Wakefield is among the largest real estate services firms with approximately 52,000 employees in over 400 offices and approximately 60 countries. In 2022, the firm had revenue of $10.1 billion across core services of Property, facilities and project management, Leasing, Capital markets, and Valuation and other services. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter.

Rebecca Rockey ​ Deputy Chief Economist Global Head of Forecasting rebecca.rockey@cushwake.com​

© 2023 Cushman & Wakefield. All rights reserved. The information contained within this report is gathered from multiple sources believed to be reliable. The information may contain errors or omissions and is presented without any warranty or representations as to its accuracy.

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