Regional banks seen shifting to risk-off mode

The failures of Silicon Valley Bank and Signature Bank and turmoil at First Republic are leading regional lenders to move more cautiously. 

Regional banks specializing in commercial real estate lending are seen taking a more cautious stance toward new originations in the wake of the failures of Signature Bank and Silicon Valley Bank and broad rescue plans for First Republic Bank. 

A key question going forward is risk management, according to a wide swath of lenders who have spoken with Real Estate Capital USA since the failure of Silicon Valley Bank on March 10. 

“We are confident the issue with small regional banks or even global banks is unlikely to lead to systemic contagion issues given the swift steps taken by regulators and central banks,” said Indraneel Karlekar, senior managing director and global head of research and portfolio strategies at Des Moines, Iowa-based Principal Asset Management. “However, we do expect a greater focus on risk management going forward, including increased scrutiny of existing debt and future underwriting tied to commercial real estate.” 

While the consensus is regional banks will remain material players in commercial real estate lending, near-term concerns over risk management mean many are scaling back their near-term activity.  

“[Smaller banks’] exposure to commercial real estate may get scrutiny at a time when real estate values are under pressure,” Karlekar said. Smaller banks have benefited from strong intervention from the Federal Reserve during the recent crisis, but the turmoil means their lending books will likely receive closer attention. 

Rising influence

Regional banks have increased their US commercial real estate lending substantially over the past few years. According to data from MSCI Real Assets published on March 23, regional and local banks represented 27 percent of all new commercial real estate originations in 2022. On average before the pandemic, regional and local banks accounted for 17 percent of activity. 

It is not yet clear where regional bank lending volume will end up in 2023, but there is a growing conviction that it will be lower. 

Matthew Tevis, managing partner and global head of financial institutions at Chatham Financial, says the Kennett Square, Pennsylvania-based risk management company has been actively advising regional and community banks across the country in the face of market volatility and additional rate hikes. 

“Many banks are tightening their credit underwriting standards, and I think that’s a reflection of a concern about what the future economic conditions are going to look like,” Tevis said. 

The Federal Reserve has been heavily involved in stabilizing the markets, overseeing the process through which New York-based Signature Bank was taken over by the Federal Deposit Insurance Corporation and later partially bought by the New York Community Bank. In a separate transaction, First Citizens Bank on March 27 acquired the bulk of Silicon Valley Bank. 

Though it’s still too early to tell, Tevis cited the potential for regulatory changes that could affect regional banks commercial real estate lending. “If the [regulatory] requirements are going to change going forward, what’s that going to do to their lending capacity, or overall pricing? Is that going to pass through in some additional pricing to borrowers?” he added. 

The sponsor’s view 

Regional banks are often seen in the construction lending markets, tapping into long-term relationships and specific market insights. Local and regional banks were a viable construction lending source in 2022 and accounted for 28 percent of activity during the year, MSCI Real Assets data showed. Though regional banks’ market share in construction financing has scaled back from 33 percent in 2021, these lenders helped to keep the market moving amid a broader lending slowdown. 

Even before the bank failures, however, regional banks were already starting to take a more cautious tack. 

“Getting into the second half of last year, the lending community in my space became very conservative. Some [were] out of the market altogether, some [were] willing to lend, but only to existing relationships and only on very conservative terms,” said Scott Lawlor, chief executive of Florida-based Waypoint Residential. “The challenge is simply that they’re moving slowly, [and] they’re more conservative.” 

Some of the slower movements were caused by the need to reduce concentration risk with a single sponsor. “In some cases, they are required by their credit committee at a moment in time to lay off part of a loan, so we might get a term sheet that says it’s contingent on [their] ability as a lender to syndicate 25 percent of it,” Lawlor added.   

Opening the door 

As regional banks pull back or offer lower leverage points for sponsors, there is a growing sense alternative lenders could see their market share rise. There also will be the ability to buy loans from troubled institutions, market participants told Real Estate Capital USA. 

“We anticipate seeing opportunities ourselves from regional banks that will be selling loans later this year,” said Adam Zausmer, chief credit officer at New York-based mortgage real estate investment trust Ready Capital Corporation. The firm has been historically active in the secondary loan purchase market, he added. 

A key difference between alternative lenders and banks will be the ability to use leverage, Zausmer added. 

“We’re certainly seeing a slowdown from the banks, and also muted activity from the alternative lenders. It’s the nature of the volatile environment today,” said Zausmer. He continued that alternative lenders like Ready Capital have the flexibility to increase leverage for strong transactions if it believes it to be prudent in specific situations and creatively structure loans to mitigate risks.  

“Leverage is our biggest edge in this market, and that’s what differentiates us from large regional banks,” Zausmer said.