When Capital Liquidity Meets Behavioral Psychology: How The SVB Meltdown May Impact Small Bank Construction Loans

The aftershocks of the collapse of Silicon Valley Bank could reach far beyond the tech sector. In commercial real estate, project sponsors who typically obtain construction loans from local or regional banks might face a very different lending environment because of SVB and the government’s response.

That concern was raised in this week’s Walker Webcast with guest Michael Arougheti, co-founder and CEO of investment management firm Ares Management Corp. Arougheti started positive, saying the federal government’s efforts to address the SVB collapse and allay concerns have so far been appropriate. 

He said the Federal Deposit Insurance Corp. might need to do more to address continuing worries and stanch the financial bleeding, but FDIC’s initial actions helped calm the markets after SVB clients tried to withdraw $42B from the bank last week.

“When the markets and information are moving that quickly — very rapidly this went from an SVB-isolated issue to impacting the confidence that the typical person has in uninsured deposits in the banking system — you're reminded just how fragile the banking system and the economy can be when you factor in behavioral psychology,” Arougheti said.

Recent events and their impact on the banking sector are no small concern in CRE because U.S. banks hold approximately $6T in real estate loans, Arougheti noted. 

He and webcast host Willy Walker, CEO and chairman of Walker & Dunlop, speculated that two likely outcomes of the SVB run could be further consolidation in the banking industry and tighter government regulation of small banks. 

“We're already seeing deposits move from smaller banks to larger banks, even though those smaller bank balance sheets are healthy,” Arougheti said. “You're going to continue to see an aggregation of capital within global systemically important banks. All of these deposits coming out of SVB, Signature and First Republic have to go somewhere, and you'll begin to see they're going to the top five banks.”

Arougheti said that capital is also moving out of smaller banks and into money markets and similar instruments because the returns there can be higher and an FDIC insurance guarantee is not a concern to borrowers. 

That exodus in itself is not a problem, as long as capital markets continue to innovate and develop “safer, more transparent ways for capital to find its way into the system,” he said.

However, this flight to safety could impact developers who normally depend on local banks to obtain construction loans, Walker said. Would-be borrowers who take their business to larger institutions might not enjoy the same close relationships they had with their local lenders. They may also find that big banks are less willing to take on risk.

“My big fear is that the federal regulators don't understand the necessity for those local relationships and how important they are to commercial real estate and local economies across the country,” Walker said. “This presents some real risk as it relates to the distribution of capital and, quite honestly, to the risk-taking that is necessary [in] commercial real estate that goes away when you get this flight to safety.”

Arougheti said the situation warrants a rethinking of how local banks are regulated to address the issues that led to SVB’s collapse but allow small banks to continue to serve local builders’ needs with capital continuing to flow into construction projects.

“Maybe banks aren't supposed to be 10 to 15 times leveraged with a repressive rate cap framework,” he said. “Maybe they're supposed to be five times leveraged with a little bit more autonomy over risk-taking in local markets, because you can't look at the sum total of the system and say one size fits all. A regional lender in the Southeast is having a completely different experience than Silicon Valley Bank.”

Arougheti sounded relatively bullish in the face of these headwinds, noting that the overall U.S. economy remains “very, very strong.” He added, though, that the calculus has changed since the SVB failure, with the economy now appearing to be headed toward a slowdown.

“As of a couple weeks ago, I would have probably said there is a likelihood of a soft landing to moderate recession,” Arougheti said. “But now liquidity is changing rapidly, and that has a real impact on the behavior of the markets, the psychology in the boardroom and around the management table. And the Fed may get what it had hoped for, which is the slowdown.” 

The guest on the March 22 Walker Webcast will be Stephen Sullivan, founder and CEO of mountain apparel brand Stio. Register here.

This article was produced in collaboration between Walker & Dunlop and Studio B. Bisnow news staff was not involved in the production of this content.

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