Silicon Valley Bank Thoughts for CRE
SVB Thoughts for CRE
Insights Into Questions That Are Top Of Mind
Over the past week, we’ve seen one of the 20 largest commercial banks in the United States, Silicon Valley Bank (“SVB”), fail and be taken over by its primary regulator. Understanding why this happened and what impacts it could have on the US banking industry and dependent industries like commercial real estate is important to all of us.
Why Do Banks Fail?
Contrary to popular belief, most banks don’t fail because they make bad loans, and the borrowers don’t pay them back. When banks fail, it is typically due to a liquidity crisis. Enhanced prudential standards, adopted by banks and monitored by Regulators, have generally limited the amount of exposure banks can have to any individual borrowing client or industry. This has been a particular focus since high-profile corporate failures like Enron and WorldCom occurred earlier this century. Coming out of the great financial crisis, we’ve seen more stringent capital requirements strengthen the cushions regulators require to guard against loan and investment losses.
As Banks have done better with overall risk management, the focus has moved squarely onto liquidity risk management and how bank treasurers and CFOs deal with their first actively rising rate environment in a generation. As rates rise, bank depositors consider alternatives to having their money sit at a local Bank. These deposit outflows need to be funded by Banks. If they need to tap into existing investment portfolios, banks could wind up experiencing losses because they need to sell lower-yielding investments at a loss to cover deposit outflows. Held to maturity, these investments would yield full face value. On the contrary, selling in today’s current rate environment, Banks turn unrealized balance sheet losses into actual losses.
In the scenario described above, if a bank experiences a large “run” by depositors, the losses incurred to cover the deposit outflows could overwhelm its capital base. Knowing this, you would expect depositors to remain calm, but many will want to be first to the window to ensure the money is available for their business. At that point, a run is underway.
The FDIC’s $250,000 individual deposit limit creates a ceiling for depositors regarding their comfort level at many institutions. Without assurances by the government, depositors would likely have no choice but to concentrate even more deposits at systemically important financial institutions like JP Morgan or Bank of America because of their size and safety. Thankfully for SVB and Signature Bank of New York, those government assurances came over the weekend.
Why SVB Failed
Silicon Valley Bank (SVB) is one of the largest commercial banks in the United States, with more than $200B in total assets and more than $175B in deposits (as of 12/31/22). SVB has been around for more than 40 years and specializes in providing banking services to technology companies. SVB is headquartered in Santa Clara, California. SVB works with many early-stage companies and the Venture Capitalists (VCs) who support them. They provide banking services to these firms and have reaped the benefits as those companies go public and/or move to later stages of corporate maturity.
Like many banks that focus on specific industries, SVB heavily concentrates on very chunky corporate depositors and does not have a significant retail presence. According to the FDIC, 89% of the Bank’s $175B in deposits were uninsured at the end of 2022. In the middle of last week, as the Bank announced plans to shore up its capital position by selling some of its fixed-income investment portfolio and issuing new stock, this news spooked many of the VCs sponsoring its clients. The VCs urged the clients to move uninsured deposits to other institutions, further aggravating the situation.
On the asset side of the SVB balance sheet, on 12/31/22, sat almost $120B in fixed-income products, principally US Treasuries. The value of those securities was written down approximately $10B at FYE2022 due to rising interest rates and the impact on market value. While unusual for a bank to have so much in securities and less than 30% of assets in loans, the lack of velocity and activity in the technology space had tamped down SVB client borrowing activity during 2022 at the exact time when rising rates were hitting their investment portfolio.
As more and more of SVB’s clients sought to move their money out of the Bank to safer havens, the Bank needed to sell more and more securities. However, it was clear that liquidating these securities at a loss would quickly swamp the Bank’s capital position. The possibility of issuing new shares dried up by the end of Thursday, and no buyer emerged, and with that, its California regulator closed the doors on Friday.
What does this mean for Commercial Real Estate?
As we step back and try to understand the lessons we should take from SVB’s failure, we must consider several things for our industry. First, on a direct basis, neither SVB nor Signature Bank of New York were material lenders in the commercial real estate (“CRE”) space. However, their failures will impact many CRE technology tenants across the country, having some impact in tech-heavy markets already reeling from their pullback of late 2022. That said, the government’s affirmative statement before the opening of business on 3/13/22 that ALL depositors of SVB would be fully insured likely will calm what could have been a very jittery market. Ultimately, there won’t be a great deal of immediate impact on a direct basis.
On an indirect basis, however, we should prepare for a couple of material impacts on the banking industry and many lenders active in the CRE space. First of all, like SVB, many of the most active CRE lenders in the country (outside of the Global Systemically Important Banks, “G-SIBs”) are banks with concentrated commercial deposit bases. At this moment, C-suite conversations are happening around the country regarding where companies hold their deposits and how comfortable they are with those banks. The idea of spreading corporate deposits around to limit exposure to FDIC insurance levels or simply moving to G-SIBs will have to be considered. We should watch these deposit flows very closely over the next days and weeks.
Perhaps more importantly, we need to think about the impact of these failures on CRE lending activity. Since rates began to rise last Spring, the activity in the debt capital markets has been very muted. Recognizing that CRE loans are, by nature, illiquid assets, Banks will have to consider committing more capital to this space in the near term while they sort out the deposit flows and try to assure their major depositors to keep their money in place. The largest G-SIB banks will likely see deposit inflows. Still, they continue to be mostly on the sidelines of CRE lending as they await the current regulatory shared national credit (“SNC”) exam results and try to determine the health status of their existing office portfolios.
Non-bank lending sources would seem to have an opportunity coming from this disruption. The importance of life company lenders and agencies will become even more apparent, as neither has the dependence on deposit flows like the banking industry. Debt funds and other unregulated lending sources still depend on Banks, as many use repo and subscription lines from commercial banks as major funding sources. Finally, CMBS will likely have an opportunity to shine here but could take the opportunity to grab yield in the absence of heavy Bank competition, making borrowing costs even more expensive. And even if each of these non-bank sources steps in to help fill the void, the construction market will continue to suffer from a shortage of capital as none of these sources provides heavy construction lending volume like the Banks.
So, as we survey the landscape for CRE, in light of this disruption in the financial services space, we need the marketplace to take a deep breath this week and hope it doesn’t overreact in ways that doomed SVB. The CRE debt capital markets are already facing headwinds as we struggle with the post-covid RTO, rising rates and a slowing economy. Ensuring we stay calm and support banks in the CRE space will help us get past this bumpy ride.
The information shared here are insights provided by John Heiberger, President of NAI Hiffman | Hiffman National and is for informational purposes only and not intended as banking investment advice.
About Hiffman National:
Hiffman National is one of the US’s largest independent commercial real estate property management firms, providing institutional and private clients exceptional customized solutions for property management, project management, property accounting, lease administration, marketing, and research. The firm’s comprehensive property management platform and attentive approach to service contribute to successful life-long relationships and client satisfaction. As a nationally bestowed Top Workplace, and recognized CRE award winner, Hiffman National is headquartered in suburban Chicago, with more than 250 employees nationally and an additional six hub locations and 25 satellite offices across North America.
About NAI Hiffman:
NAI Hiffman is one of the largest independent commercial real estate services firms in the US, with a primary focus on metropolitan Chicago, and part of the NAI Global network. We provide institutional and private leasing, property management, tenant representation, capital markets, project services, research, and marketing services for owners and occupiers of commercial real estate. To meet our clients’ growing needs outside of our exclusive NAI Hiffman territory, we launched Hiffman National, our dedicated property solutions division, which provides property management, project services, and property accounting services across the country. NAI Hiffman | Hiffman National is an award winning company headquartered in suburban Chicago, with more than 250 employees strategically located throughout North America.