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

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.”

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

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