Last week I pushed back on the idea du jour being reverberated around the echo chamber, that commercial real estate was going to bring the entire financial system to its knees. I cited a report that showed just how little of the country’s building stock was in danger of getting foreclosed on and how healthy most of the outstanding loans are when it comes to loan to value. Yesterday news came out that First Republic, one of the banks that had escaped bankruptcy back when SVG and Signature did, is again in a precarious financial position.
According to the earnings call First Republic is still struggling to stay solvent because, at least according to them, the news about their near failure caused even more of a run on deposits, particularly by their bread and butter wealthy clients that tend to have more than the FDIC insured $250,000 deposited.
The situation is bad for the bank and the majority of the earnings call was dedicated to providing the organization’s path forward. First, they are trying to boost their deposits back to previous levels. They plan on doing this by “focusing on insured deposits from new consumers, small businesses, and nonprofit organizations.” They did not give much information about how exactly they were going to get these new customers, only that “uninsured deposits will remain a much smaller percentage of total deposits than in the past.”
They are also going to be reducing headcount by 20 to 25 percent. This, along with other cost-cutting measures should hopefully reduce expenses “to align with our focus on reducing the size of the balance sheet.”
The third strategy is to reduce the size of their loan balances. They intend to do this by reducing their lending volume, focusing on loan originations that will be sold to third party servicers, and by selling off some of their current portfolio.
This is where commercial real estate comes in. Their commercial mortgage securities will likely be one of the assets that they will sell. I say that because it is likely one of their most secure parts of their lending portfolio. On the earning call their CEO Mike Roffler made it a point to explain just how safe their commercial real estate loans are, “I want to note that our total commercial real estate portfolio represents only 6 percent of total loans and has an average loan to value ratio of just 46 percent,” he said. While 6 percent might not be a lot it is certainly enough to help ease the pain of the mass exodus of depositors that they experienced this quarter.
There is still the very real possibility that First Republic will need a government bailout. If that happens the company will likely be dissolved and have its assets sold off, just like what happened with SVG and Signature. But no matter what happens to the bank there will always be a buyer for commercial real estate debt, especially at 46 percent LTV. That is because buildings, unlike many other assets that act as loan collateral, have real value. One asset class might suffer more than others and loans will likely get defaulted on, but the way that the commercial lending industry has set up their business, a mass default remains unlikely. And after all of the potential blame that the media put on commercial real estate, it might be the very thing that saves our banking system.
This article has some really great maps showing where the highest net-worth First Republic clients live.
What we are reading
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