How Regional Banking Consolidation Threatens Commercial Real Estate

Two months after the sudden demise of Silicon Valley Bank (SIVBQ) and Signature Bank (SBNY), the U.S. regional banking system is no closer to finding a healthy equilibrium than it was when the crisis of confidence began March 8 with the collapse of Silvergate Bank in La Jolla, Calif. 

The standing fear now among economists is not whether another regional bank will fold, but which larger institution will grow stronger from the latest FDIC-induced consolidation, where shotgun marriages between lending institutions sold for pennies on the dollar to their Too Big To Fail overlords has become the feature, rather than the bug, of a federally engineered response. 

“It kind of reminds me of the situation in 2008 when the question was, ‘What’s the next bank that’s going to go down, and who is going to short them?’ ” said economist Joel Naroff, president of Naroff Economics. “The fact is, we have an awful lot of concentration of funds in this economy, and the larger businesses get, the more exposure the economy has to these kinds of situations.” 

Already, the system has seen JPMorgan Chase (JPM), with more than $2.6 trillion in assets, swallow First Republic Bank (FRCB) (and its $92 billion in deposits and $209 billion loan book) for a mere $10.6 billion; New York Community Bancorp buy Signature Bank (and $38.4 billion in assets) for only $2.7 billion; and First Citizens BancShares acquire SVB’s $72 billion loan portfolio and $56 billion in deposits for $16.5 billion, all at the direction of the FDIC.       

“Like anything else, you don’t want more and more banks getting bigger so you have fewer and fewer competitors who provide liquidity for the economy,” Naroff said. “The risk of bad decisions gets greater because now the $100 billion bank becomes a $200 billion bank, and if they go under it’s just another problem that’s out there.” 

The U.S. banking system has roughly 4,700 FDIC-certified lending institutions, which have shrunk from more than 10,000 the system had prior to the 1994 Riegle-Neal Interstate Banking Act, which eliminated barriers to banks operating across state lines and created a uniform set of rules for national banking. Hundreds of mergers followed, even as the number of individual branches rose.  

“Riegle-Neal really transformed the character of American banking,” said Robert Hockett, professor of corporate law and financial regulation at Cornell Law School. “Previously, we had an illustrious history of keeping banks local and regional, and the reasons were it ensured there was plenty of capital available for small business in the real economy in every state of the union rather than forcing everyone to go hat in hand to New York, Philadelphia or San Francisco if they wanted banking services.” 

Hockett wasn’t surprised that the now-failed SVB, First Republic Bank, Silvergate Bank and Signature Bank were all headquartered in San Francisco and New York City. 

“It seems to be long understood that the huge coastal banks are interested in making their money on the global financial markets, speculating on the tertiary and secondary markets,” he said. “The 1990s removed restrictions of interstate banking and branching and gave a shot in the arm to the forces of financialization.”

These same forces are now at work threatening the overall health of the broader banking sector.  

The tremors of consolidation ruptured further May 4, when the financial system experienced a mini-armageddon. Stock values of almost every regional bank saw sweeping declines that day amid first quarter earnings reports, inflaming short sellers to prey on vulnerable lending institutions and spooking depositors to ditch their loyalties for deeper balance sheets. 

Shares of Western Alliance Bancorporation of Phoenix ($67 billion in assets) fell 38 percent that day; shares of Zions Bancorp of Salt Lake City ($90 billion in assets) dropped 12 percent; while First Horizon of Memphis ($79 billion in assets) dropped 33 percent after TD Bank walked away from a merger agreement. 

Perhaps most alarming to a fragile system was the news surrounding PacWest Bancorporation of Los Angeles, with more than $41 billion in assets. Shares of PacWest fell 50 percent that day, and dropped another 22 percent the next week after the bank announced it was exploring a sale and had reported deposit outflows of nearly 10 percent for the week ending May 5. All told, PacWest stock has lost 80 percent of its value since March 8. 

Looming over every share price slide is the threat of instantaneous outflows: Prior to its demise, SVB watched $40 billion disappear in 24 hours, while First Republic lost $100 billion in deposits in just over a month, largely due to the now interconnected nature of online banking and social media.  

“Any bank that’s not considered ‘Too Big To Fail’ is worried right now about their deposit base,” said Manus Clancy, senior managing director at Trepp, an analytics and financial research firm. “There was a level of calm, but then First Republic and PacWest came out and said, ‘Our deposits are down 20 percent,’ and that re-triggered the concern.” 

For commercial real estate, the consolidation of the regional banking sector carries numerous unintended consequences, and very few of them are good. For one, the small to mid size commercial banking houses — those holding between $1 billion and $250 billion in assets — serve as the guardians of capital for much of commercial real estate. 

A recent report from Goldman Sachs determined that banks with less than $250 billion in assets account for 80 percent of CRE lending and 40 percent of consumer lending. Moreover, an April 12 report by JPMorgan Chase determined that CRE loans makeup 28.7 percent of assets at small banks, compared to only 6.5 percent at big banks. 

Under bank consolidation, “You will be more subject to a corporate machine,” said Christopher Thornberg, founder of Beacon Economics. “People in a corporate office 2,000 miles away start making decisions on whether you get that loan when you feel that decision should be based on someone working in your same city.” 

Data compiled by Trepp, and reported May 16 by Reuters, underscores the vulnerability smaller banks have to a depressed CRE market. A study of 4,706 FDIC-insured banks found that 763 have either construction loan or CRE loan thresholds that exceed 100 percent and 300 percent of their total assets, respectively, with 23 percent of banks with assets between $10 billion and $50 billion exceeding at least one ratio.

“They’re all concerned right now,” said Clancy. “So rather than putting money out to work on construction projects or commercial real estate financing, they’re saying ‘Let’s squirrel away our cash so if a deposit run comes we’re liquid enough to endure it’ — which means less capital available for developers.” 

Jamie Woodwell, head of commercial real estate research at the Mortgage Bankers Association, an industry trade group, said that recent data from the Federal Reserve has revealed contradictory impulses in the present capital markets system.  

On one hand, in aggregate, the number of commercial and multifamily mortgages on bank balance sheets has grown in the last four weeks. On the other hand, senior loan officers have tightened their standards for commercial and multifamily mortgages, with two-thirds of banks tightening credit standards, and three-fourths reporting mortgage demand declines, according to Woodwell.  

“While there are a lot of questions about the availability of mortgage debt, I think there are equal questions about the demand for mortgage debt,” Woodwell said. “I think you’re seeing a little bit of a slowdown of demand starting this year that may be even exceeding anything you’re seeing in terms of supply in capital.” 

These questions about mortgage debt availability are directly tied to banking system stability, as any questions around solvency could result in a containment of credit for the economy, especially CRE capital markets, according to Tomasz Piskorski, professor of real estate finance at Columbia Business School. While government-sponsored enterprises Fannie Mae and Freddie Mac insure a good chunk of residential real estate loans with an iron-clad federal guarantee, no such guarantees exist from the regional banks in the non-agency CRE lending universe, creating a cycle of suspicion and credit contraction, he noted.     

“These banks aren’t keen to lend because they are concerned with liquidity and are dealing with issues of solvency,” Piskorski said. “If the banks didn’t have access to insured deposit funding, they’d have to hold much more equity and they’d be making much less loans.” 

Piskorski also highlighted the challenges some CRE loans will face in the event of increased consolidation, noting that distressed loans from a stable bank stay on the balance sheet, while distressed loans sitting in CMBS trusts or with special servicers don’t have the same direct channel to modifications and workouts and are likely to head into foreclosure. 

“A bank at the brink of collapse might not be there when your loan is maturing,” he said, “and the person controlling the distressed assets of the bank might say just pay us back or you go into foreclosure.” 

Outside of the concerns surrounding distressed CRE loans, Piskorski noted the complexities capital markets could encounter under a weaker regional bank umbrella, particularly a lack of willingness from distressed banks to provide bridge loans or refinancings to CRE projects. 

“Because the banks are under such significant financial pressure and insolvency risk, they will not have access to funding to provide extra bridge financing for some of these real estate projects to survive,” he said. “It could really have a spillover effect on the real economy.”

So what can possibly be done to stem the cycle of short-selling, stock price declines, depositor flights and impending bank failure? 

One thing many economists agree is needed for increased stability is for the Federal Deposit Insurance Corporation to raise the $250,000 deposit guarantee threshold. Even FDIC Chairman Martin J. Gruenberg recommended in a May 1 letter to Congress lifting the cap to provide targeted coverage to business deposits. The Mid-Size Bank Coalition for America requested in March that regulators guarantee all deposits for the next two years, regardless of size or account, arguing that only an unconditional policy could stem the tide of bank runs. 

Even a conditional guarantee would help stem the bleeding of regional banks losing worried depositors, according to multiple economists, as so much of banking is tied to perception of risk.   

“If regulators upped the deposit limit to $5 million or even $10 million, that would be an instant panacea for the regional banks,” Trepp’s Clancy said. “I’m not sure there’s the political appetite for that, but it would certainly end the crisis and turn things on a dime.” 

Professor Hockett agreed on the need to raise the cap and said he is currently working with some members of Congress on legislation to remove all coverage caps while retaining the risk-price premium assessment system the FDIC introduced in 2005.  

“Unless we remove the caps on deposit insurance, at least for small business transaction accounts, we will continue to see pressure on the deposit base of regional banks and more and more of that will flow to the Big Four banks because they are Too Big To Fail,” Hockett said. 

And in the event Congress does nothing and keeps the $250,000 cap in place? 

Well, in that case, expect the Invisible Hand to make dozens of banks — and thousands of branches — disappear by the end of the year. 

“When all it takes is an app to move $100 million in an hour, why would you hang around? What’s the point?” Naroff said. “The most important aspect, the implication of this, is we are moving toward concentration.” 

Brian Pascus can be reached at bpascus@commercialobserver.com