Commercial Real Estate Lending Headwinds, the 2024 Regulatory Focus on Credit Risk and Liquidity, and What Small- and Medium-size Banks Need to Know.
Commercial Real Estate Loan Portfolios are under increasing pressure. The
troubled commercial real estate market is facing a record volume of maturing
loans, significantly increasing prospects for a surge in defaults as property owners
are forced to refinance at higher rates. Heightened regulatory focus on credit risk
and liquidity signal the need for preemptive strategies. Here we present a viable
solution for lenders.
Key Takeaways
1. Bank CRE loans totaled $2.972 trillion in January 2024.
2. According to research from Apollo, small banks account for nearly 70% of all CRE loans
outstanding.
3. Nearly 1,900 banks with assets less than $100 billion have CRE loans outstanding greater
than 300% of total capital. That level of 300% may indicate a lender is exposed to
significant risk of CRE concentration, according to the FDIC.
4. CRE loan delinquency rates are increasing monthly and there are substantial CRE loans
maturing in the next two to three years.
5. The CRE sector is likely to face a significant challenge as loans mature at higher rates,
increasing the difficulty of refinancing and adversely impacting debt service coverage.
6. CRE lenders and portfolio managers need to engage third party professional guidance in
order to navigate the headwinds of a potentially stormy horizon.
7. Small- to medium-size banks are the most vulnerable, and the Federal Reserve is willing
to allow weak banks to fail.
What brought us to this point?
The pressure on CRE has been created by a convergence of factors, including a sharp increase in
interest rates, rising costs and reduced operating margins, income pressure, tighter financing
needs and a wall of debt maturing over the next 18 months…The imminent refinancing needs of
CRE owners are another source of stress in the sector, with nearly $1.1 trillion worth of commercial
mortgage loans expected to mature before the end of 2024, according to Goldman Sachs Global Investment Research. Given the balloon maturities common in commercial mortgages, many
borrowers will have to refinance their existing loans at higher rates.
The Fed has hiked interest rates 11 times since January 2022 to curb inflation, making CRE credit
tighter. The collapse of Silicon Valley Bank, Signature Bank and First Republic Bank in March 2023
worsened the crisis. Lenders’ caution is reflected in stringent credit policies, with loans originated
only to those borrowers who have demonstrated strong creditworthiness.
There are substantial CRE loans maturing in the next two to three years. The CRE sector is likely
to face a significant challenge, as, based on current market conditions, low-interest loans mature
at higher rates, increasing the difficulty in refinancing. Increasing defaults at maturity would
affect the weaker CRE assets, depending on asset quality, type and location.
Where are we now?
Small- and Medium-size Banks:
CRE holdings as a proportion of total risk-based capital above 300% may indicate a lender is
exposed to significant risk of CRE concentration, according to public guidelines from the Federal
Deposit Insurance Corporation (FDIC). In total, nearly 1,900 banks with assets less than $100
billion had CRE loans outstanding greater than 300% of equity, according to Fitch.
Fitch, in a detailed report in December, also said if prices
decline by approximately 40% on average, losses in CRE
portfolios could result in the failure of a moderate number
of predominately smaller banks.According to S&P Global, “Regulators have reiterated the
importance of banks maintaining strong risk management of
their CRE portfolios, particularly for institutions with elevated CRE
concentrations. The FDIC has also said that it is increasing
examination staff in anticipation of more "problem banks" and
plans to subject institutions to tougher exams.