Small Banks Say They Avoided A CRE Crisis. That Doesn't Mean They're Lending Again

Since last year, experts warned that a wave of commercial real estate loan maturities was likely to create systemic issues among local and regional banks that could lead to a slew of failures.

Except that has yet to happen. After five banks failed in 2023, spurred on by the demise of Silicon Valley Bank in March, there has only been one bank failure thus far in 2024 — Republic Bank. 

Tom Cornish, the chief operating officer of Florida-based BankUnited, said the commercial real estate that backs the loans made by community and regional banks aren’t the loans in trouble.

“For the most part, regional and community banks tend to be bigger lenders of the suburban office market. And suburban has performed much better,” Cornish told Bisnow. “The part of the office industry that is really most troubled tends to be your very large, towered [central business district]-type properties.”

Smaller banks also tend to focus on commercial buildings owned and operated by local businesses, such as small manufacturers who take warehouse space or local restaurants and boutiques occupying local storefronts, Cornish said. Banking experts and executives expressed the same sentiment to The New York Times last week.

“The focus has been on office as that is the weak category,” Flushing Financial CEO John Buran told the Times. “Most community banks don’t have the type of exposure.” 

There are some signs that fears of a commercial real estate meltdown may be premature. The balances on commercial real estate mortgages were 97% current or less than 30 days late as of the second quarter, according to the Mortgage Bankers Association, up from 96.8% at the end of Q1. 

Office loans are still a problem, with delinquencies rising from 6.8% to 7.1% between Q1 and Q2, according to MBA. But the highest risk for office loan defaults remains in major financial centers, according to a recent study from the debt collection firm The Kaplan Group. San Francisco landlords faced the highest risk of loan default, followed by Seattle, Houston, Des Moines and Atlanta.

Small and regional banks rarely make big loans in major urban markets. Cornish said community and regional bank loan portfolios with office exposure are typically not plagued with companies reducing footprints as they cement a hybrid work model.

“Every bank is different. That might be true for one regional bank’s portfolio,” said Dean Dulchinos, AEW Capital Management's head of debt portfolio management. “But it’s fair to say regional banks are less involved in the large CBD offices.”

Some banks are still looking to reduce their exposure, but not as dramatically as some predicted.

JLL Senior Managing Director Chris Drew said banks have been conducting more one-off note sales over the past few months, but by and large, are holding onto their real estate loan portfolios. 

But banks also are not lending to new CRE deals, at least not directly. Banks' share of the commercial real estate lending market was below 25% in the first quarter of this year, compared to more than 40% in Q1 2023, according to CBRE.

Private credit lenders have increasingly stepped into their place, taking advantage of bank pullback on CRE lending as the Federal Reserve maintains a higher-for-longer interest rate policy to combat inflation. 

Private credit funds from companies such as Apollo, KKR, Ares and BlackRock have increased their activity, especially for bigger loans that can range from $25M to $500M or more, Drew said. Private lender fundraising for mezzanine debt alone reached more than $40B by the third quarter of 2023, far surpassing 2022’s total of $26.2B, according to Preqin data cited by RSM.

“The debt funds are where you’re getting very large deals done today,” he said. 

​​Those loans are more expensive for borrowers than what banks had been offering in the past, in some cases as much as 100 basis points spread from the U.S. Treasury rate, Drew said.

Dulchinos said private capital also is better suited to handle the actual CRE assets if borrowers default.

“When you think about it, banks lend on commercial real estate, yet banks are not well suited to own real estate. It’s sort of a mismatch,” he said. “They’re making loans on CRE, yet they don’t have an equity team that can manage the CRE if they take it back.”

Avana Cos. CEO Sundip Patel, whose firm operates both a bank and the $250M fund in a joint venture with an institutional investor, said his firm is seeing a flood of CRE borrowers come to them for financing.

“The fact that private credit is the darling of Wall Street,” Patel said, “I think it’s just going to accelerate. We’re taking the place of where banks were.”

Dulchinos said AEW evaluated close to $20B in potential CRE financing deals last year, mainly focused on multifamily and industrial projects. He expects that level of activity again this year, with AEW likely to do even more deals than in 2023. As long as interest rates remain elevated and regulators continue to apply pressure on banks to reduce their exposure to CRE loans, borrowers will continue to turn more often to private capital for dollars, Dulchinos said. 

“I’ve been in CRE lending for most of my career. CRE lending has been a very good part of the market for decades,” he said. “But I think right now it’s potentially a better opportunity, given the shifts we have seen in the capital markets.”