Bank Uncertainty Opens the Door for Private Lenders

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By now, nearly everyone has heard of Silicon Valley Bank, Signature Bank, and First Republic Bank. All three banks failed spectacularly sparking a run on other regional banks and a flight of deposits from smaller banks to large financial institutions that are already deemed too big to fail. These bank failures were some of the largest bank failures in US history. Silicon Valley Bank, with $209 billion in total assets at the time of its failure, was the third-largest bank failure ever and the largest since the Great Recession.  At the time of its failure, First Republic Bank had total assets of $229 billion, making its failure the second largest bank failure in US history, second only to the failure of Washington Mutual Bank in 2008, which at the time had $309 billion in total assets. 

These bank failures not only triggered a run on deposits at small to medium sized banks, but they also evidenced a potential contagion of systemic risk in the US banking system. It appears this risk is concentrated in small-to-medium-sized banks and is largely triggered by an erosion of their deposit base caused by jittery depositors. This small/medium bank crisis is expected to exacerbate the retraction of commercial lending activity by small and medium-sized banks. According to a recent survey conducted by the Federal Reserve Board, nearly half of all US banks have tightened their lending standards. Commercial banks have already reduced their commercial real estate lending. Such lending dropped by $105 billion in the last two weeks of March 2023, the largest such drop recorded by the Federal Reserve going back to 1973. Of this drop, $45 billion was attributable to small banks reducing their commercial real estate originations.

For private lenders, the question to ask is why does this matter? With small and medium-sized banks representing nearly 80% of all commercial real estate lending, a pullback by these banks could create a financing gap. This gap provides a tremendous opportunity for private lenders to attract new clients who will have unmet demand for commercial real estate loans. The demand for such loans could be substantial as hundreds of billions of dollars of commercial real estate loans are scheduled to mature in 2023 and 2024, most of which are held by small and medium-sized banks. 

Private lending thriving during times of economic uncertainty is not a recent phenomenon. During the COVID-19 pandemic private lenders stepped in and provided much-needed loan capital when traditional sources dried up.  How will private lenders step in the current crisis? Will they? If they do, how will private lenders do so without taking undue risk? 

Private lenders should determine what asset class they are willing to lend against. Will they finance office space, or will they shy away from this class due to COVID-induced work from home policies? Will lenders finance hospitality properties or will they avoid this asset class altogether? Another asset class that will face tremendous pressure is retail properties. Retail properties face dual pressures of economic uncertainty and changing consumer habits that have been trending towards more online shopping and less brick-and-mortar shopping. Another area dominated by banks that may present an opportunity for private lenders is construction lending. Will private lenders provide ground-up construction loans, or will lenders stick to fix and flip rehab loans? 

Dealing with borrowers who are unable to refinance their existing commercial real estate loans with traditional funding sources could also present unique challenges for private lenders.  First, this group of borrowers may suffer from sticker shock when they see their interest rates jump from traditional bank rates to private money rates that may touch double digits.  Second, some loans are guaranteed with limited or carve out guarantees that are typical in the CMBS or CLO securitized world. The guarantors under these types of loans are not accustomed to providing full recourse guarantees and may object to doing so.  Another issue facing these borrowers will be their ability to provide capital to pay down their loans if property valuations decline resulting in loan-to-value ratios skyrocketing above acceptable limits. Another concept this group of borrowers may not be accustomed to is providing reserves for the payment of interest. Many traditional sources of real estate financing do not require interest reserves, whereas they are staples in the private lending space. Another crucial distinction between traditional financing and private money is the financing term. Many traditional sources of real estate financing offer terms between ten (10) and fifteen (15) years. Conversely, private money loans are traditionally structured as short-term debt of twelve (12) months or less. Private lenders may need to extend the length of their loan terms to provide borrowers with enough time to weather the economic uncertainty.

To capitalize on this opportunity, private lenders need to press the main advantages they have over banks.  Specifically, private lenders need to let this potential new class of borrowers know private lenders have a much faster approval process when compared to banks. In a typical situation, a bank will take weeks to give its final approval for a real estate loan. It is not uncommon for a bank to engage with a borrower during a lengthy due diligence process only to reject the loan at the last minute, leaving a borrower scrambling to obtain financing. Most private lenders can approve and close a loan in a matter of days.  Most bank borrowers have no experience with this level of expediency. Similarly, private lenders should emphasize their ability to approve a loan with less requirements than what are typically required by a bank.  Private lenders should also let potential borrowers know they will generally offer more flexible terms than most banks, including not requiring a borrower to move their deposit relationship from an existing bank to the private lender. Moving deposit accounts is an arduous process that most borrowers hope to avoid. Finally, private lenders have the tremendous advantage of being actively engaged in the business of making real estate loans, whereas banks are pulling back and limiting their real estate exposure. If private lenders push their advantages, they have a major opportunity exploit bank pullback to gain market share and expand their client base. 

 If you have any questions regarding private lending, the team at Geraci is ready to help. Contact us today for a consultation.

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