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Banking Blues: Underwriters Tighten CRE Lending Standards Amid Interest Rate Woes

banking and commercial real estate


Interest rates have been on the rise for more than a year as the Federal Reserve tries to curb spending and, hopefully, inflation. As borrowing cost increases have forced both investors and consumers to rethink their priorities, near-term commercial real estate forecasts have zeroed in on the Fed's policy movements as a linchpin to credit conditions and industry performance. However, history suggests that how banks set and adjust credit standards is far more informative about the future of lending activity than rates themselves.

On May 8th, the latest release of the Federal Reserve’s Senior Loan Officer Opinion Survey (SLOOS) provided an updated view into how lenders have attuned loan standards to adjust to today’s tighter financial environment. More specifically, the Spring 2023 SLOOS also included questions specific to how banks have changed policies on commercial real estate loans over the past year.

During the first quarter of 2023, the share of lenders that indicated they are tightening loan standards for commercial real estate loans increased across all sub-types. A net 73.8% of banks showed tighter lending standards for construction and land development loans in the first quarter of this year compared to a net 69.2% in Q4 2022.

Similarly, 66.7% of banks indicated tighter standards for nonfarm nonresidential loans compared to 57.6% at the end of 2022. Meanwhile, 64.5% of lenders indicated tighter standards for multifamily loans in Q1 2023 compared to 56.7% in Q4 2022.

banks tightening lending standards, senior loan officer opinion survey

Interestingly, despite the steepest rate hikes likely behind us, lenders are increasingly worried about near-term financial conditions as growth slows and banks attempt to absorb rising borrowing costs. According to the survey’s findings, the most frequently cited reasons for tightening standards were a deterioration in credit quality within their loan portfolios, reduced risk tolerance, and concerns about bank liquidity and deposit outflows.

Most market watchers assumed that the Fed’s tightening efforts would slow down transaction volume in CRE markets, but recent bank failures have amplified concerns surrounding CRE's reliance on bank lending. Specifically, mid-sized regional banks, which are experiencing some of the most significant balance sheet distress in today's rate environment, remain one of the largest underwriters of commercial real estate loans.

The Spring 2023 SLOOS found that tightening lending standards was more common among mid-sized banks than their larger counterparts. On the one hand, this lends credence to some economists' concerns about CRE contagion risk, though with a grain of salt.

Some estimates place regional banks in the ballpark of holding 65-80% of all CRE loans— which, upon a closer look, appears to be greatly overstated. According to data from Moody’s, the 135 US mid-sized regional account for closer to 14% of debt on income-producing properties—which still represents a plurality of bank-issued loans (38.9%) but a much more modest level than some other projections.

Contrarily, the top 25 largest banks hold 12% of outstanding debt, while smaller community banks, which total 829 nationwide, account for roughly 10% of CRE debt.

bank Commercial real estate debt

The April 2023 SLOOS signals that commercial real estate loan issuance is likely to slow in the coming months, and the combination of falling loan demand and tighter credit standards will place downward pressure on prices.

As evident in the survey data, standards for commercial loans are tightening faster than for multifamily loans, which should be further anchored by Fannie and Freddie serving as a liquidity backstop for residential markets. Within the commercial sectors, office property loans that are up for refinancing, for example, are likely to face more scrutiny than their industrial asset counterparts.

As signs increasingly point towards an impending pause in interest rate hikes, how banks approach changes to credit standards during the second quarter of 2023 and beyond will be the subject of outsized and appropriate attention.


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