Thoughts about CRE.

We wanted to share some thoughts with you about recent events this week, which, while not CRE-specific, do have potentially big implications for CRE (and create opportunities).

The recent events (SI, SVB, SBNY) as a catalyst moment for regional/community bank loan portfolios. These events are pulling forward a credit cycle which I wasn't expecting to surface for a year or more. 

There are multiple pockets of credit that are likely to come under stress in a high inflation, high rate environment - including most near- and all subprime consumer, certain corporate sectors, and CRE. 

Given how aggressive many regional / community banks were in the last few years with their CRE books, I expect these exposures to pose some of the biggest risk for these banks. If marked to market today, 2021/22 CRE values would be down about 20-25% (some could argue more), and bigger value drops will come with higher rates. Mark downs of this size would wipe out most of the equity on many of the loans that were aggressively originated.

While many banks likely won't write the collateral values down like this, as they don't have the wherewithal to handle that volume of bad credits, the current situation leaves many of these banks with trapped capital in CRE loans. I suspect these banks' management teams will be faced with three alternatives:

1) Wait it out – which will either result in the banks underperformance, but survival (trapped capital will be a growth drag) or bank failure

2) Entity-level transaction and further banking consolidation (e.g., merger of equals or acquisition by larger firm – either PE or bank)

3) Loan, note or portfolio sales – likely the quickest way for these banks to free up otherwise trapped capital, but requiring haircuts

Given that option #3 is the only one which bank management teams have the most control of the outcome, I'd anticipate seeing way more note/loan sales in the coming year. 

Questions, comments, criticisms welcome.