Results from the latest Senior Loan Officer Opinion Survey (SLOOS) indicate that banks are taking a more cautious stance toward commercial real estate (CRE) by further tightening their lending standards across all CRE loan categories: non-residential/non-farm, multifamily and construction (Exhibit 8).
The SLOOS on bank lending practices conducted by the Federal Reserve Board of Governors (Fed) assesses the standards and terms on which banks are granting CRE loans. The latest results point to changing dynamics in the banking sector, particularly regarding CRE lending, and provide key insights into the outlook for the CRE debt market.
Tightening bank lending standards appear to be spurred by an uncertain economic outlook, deterioration in the quality of existing loan portfolios and an anticipated increase in problem assets. The lending environment is also influenced by the Fed's recent decision to continue raising interest rates, bringing the target range for the Fed's funds rate to 5.25-5.5%. Banks indicated that they are experiencing decreasing demand for CRE loans as borrowers face higher debt financing costs.
Additionally, the Basel III regulatory reforms will increase regulatory capital that banks must hold. While enhanced regulatory reforms are primarily targeted at banks, they will indirectly impact the non-bank lending landscape; pushing banks to retreat from certain types of loans will open up a new lending space for non-bank lenders. Looking ahead, banks anticipate even tighter lending standards for the remainder of the year.
Stricter lending criteria coincides with $1.9 trillion of CRE loans that are due to mature between 2023 and 2025, of which over half, or $983 billion, are bank loans (Exhibit 9). Borrowers who obtained loans when interest rates were low will face much higher financing costs, and will no doubt exercise every feasible option to extend their existing loans. However, some borrowers will struggle to secure the needed financing.
This scenario will lead to a gap in the lending market, offering non-bank lenders a chance to step in and meet the underserved loan demand. The increase in interest rates could translate into higher yields on new loans, which would positively impact returns. The flip side will be increased financial burden and an influx of borrowers unable to meet bank lending standards. This could potentially introduce a higher risk profile leading to heightened risk of defaults. While this necessitates more robust risk assessments to avoid potential pitfalls, in the longer term it will strengthen the profile of loans in the CRE debt markets.
The SLOOS acts as an early warning system for potential disruptions or significant changes in the CRE debt market, providing a forward-looking view that reflects banks' internal assessments and anticipations. Therefore, it serves as a valuable tool to gauge the health and future direction of the CRE debt market. Understanding changes in lending standards, demand for loans, interest rate outlook and credit availability help in anticipating market trends and making informed decisions. While these developments suggest a more challenging borrowing environment for CRE, they also
