The collapse of three US regional banks – two of which were active lenders to private real estate managers – in less than a week underscores the myriad risks the industry is now facing, market sources told affiliate publication PERE.
On Friday, Silicon Valley Bank was shut down and taken over by the Federal Deposit Insurance Corporation in the second-biggest bank failure in US history. Two days earlier, Silvergate Capital Corporation, the holding company of Silvergate Bank, announced its intention to wind down operations and voluntarily liquidate the bank. SVB’s collapse was then followed two days later by New York-based Signature Bank’s closure by the FDIC. The failures had much to do with the banks’ concentration of activities in troubled sectors: SVB had a large exposure to start-ups and venture capital firms, while Silvergate and Signature were major crypto banks.
SVB and Signature, along with San Francisco-based First Republic Bank – which is also under pressure because of contagion fears – are also active lenders in private real estate.
“These three happened to be among the most prominent players for the regional banks in subscription facilities,” according to Roger Singer, partner at law firm Gibson Dunn & Crutcher. While SVB and Signature were both lenders to well-established managers with large credit facilities, First Republic generally provided smaller credit facilities to emerging managers, he said.
Singer noted that the terms of subscription facilities typically require the fund to maintain some or all of its bank accounts at the lender’s institution. In addition, managers may also have the funds borrow on the property level from these lenders. SVB, for example, had $2.6 billion in commercial real estate loans as of 31 December, according to the company’s most recent annual report. Signature’s exposure to the asset class was much larger, with $33.1 billion in total commercial real estate loans at year-end 2022, the bank’s 2022 annual report showed. Meanwhile, First Republic had $8.5 billion in commercial mortgages as of 31 December 2021, according to its 2021 annual report – its most recent available.
These bank failures consequently raise three major issues for real estate borrowers, Singer said. The first is safety of and ready access to deposits, despite the Federal Reserve Board announcing on Sunday it would provide additional financing to guarantee the customer deposits at all eligible institutions. This is particularly the case when managers hold significant amounts of money for short periods of time, such as for pending distributions or pending re-investment. The second is for capital calls from investors, where borrowers may be holding capital for a period of time to pay down a subscription line or invest it into assets.
“There were many fund managers who did not sleep well this weekend”
Singer pointed to one SVB client – a US manager with a $600 million fund – that had to push back the closing of a deal where the capital call was originally scheduled for the end of last week. Amid the turmoil surrounding SVB’s collapse, the fund sponsor could not access the capital in its account, while some of the capital contributions were not accepted or were cancelled by the investors. “There were many fund managers who did not sleep well this weekend,” he added.
Scrambling for replacement capital
The third significant issue for real estate borrowers is the fact that many have planned their financial activities based on having credit facilities. “One of the advantages of subscription facilities is quick access to cash,” Singer explained. “You don’t have to wait 10 business days [for a capital call]. So there are people now who are scrambling around to replace those credit facilities.”
Managers are accustomed to closing on deals with financing off the subscription line, especially during a fundraising period, to avoid or minimise true-up interest or other adjustments. The concern now is whether other banks have capacity or capital to lend, and, even if they do, if they have the time to put those credit lines in place quickly, he remarked.
Among the other active subscription lenders are large money-centre banks such as Wells Fargo, Bank of America and JPMorgan. But in many cases, borrowers were able to get better access to capital or service from regional banks, particularly if they were not a sizable company, Singer noted: “Smaller managers have trouble getting attention from larger banks.”
Despite subscription lines of credit being fundamental to the fund management business, “there aren’t really a lot of good options for lenders,” concurred a US-based market source that declined to be named. “So a lot of fund managers ended up working with these smaller regional banks to get subscription lines.”
With asset-level financing, managers have similarly diversified their relationships to include regional banks as money-centre banks pulled back from financing deals, as PERE previously reported in its December 2022/January 2023 cover story. But with such loans, “there’s less of a counterparty issue, because you agree to the deal and borrow substantially all at once”, Singer said. “The problem with the subscription line is that you’re drawing, repaying and re-borrowing over time, so you’re expecting them to perform repeatedly over the course of several years.”
Real estate borrowers are now looking at all three issues and questioning how to manage financing deals in the future. In terms of working with regional banks, which are subject to far less regulatory oversight than the largest US financial institutions, “we’re all aware of a theoretical counterparty risk, but this wasn’t seen as a significant risk”, Singer said. “This has highlighted the fact that it may be more significant than managers thought. On the other hand, how prudent is it to plan your financial dealings based on a once-in-a-decade or more event?”
Other banks that could step into the void left by SVB and Signature could include global and US institutions such as Morgan Stanley, PNC and Key Bank. “I think it will become a little bit tougher for the regional players,” he predicted. “For a while, people are going to be concerned about whether it’s prudent to be transacting with a smaller bank.”
Transparency from managers
One positive aspect from the past week’s bank failures has been managers taking a proactive approach to keep investors informed on their firms’ relationships – or lack thereof – with these lenders. For example, True North Management, based in White Plains, New York, disclosed in an email sent to investors and seen by PERE that it had been a credit facility borrower with SVB for its first three funds. “Oddly enough, prior to SVB’s failure, this was set to change in the next one to two weeks as we recently established a new Fund IV credit facility at First Republic and we were in the process of moving our deposits and operating accounts to them,” the firm wrote.
The timing of the SVB collapse also coincided with True North having “an atypically large cash balance” of $30 million in the main operating accounts for Fund III, resulting from the firm’s recent office disposition activity and the receipt of delayed sales proceeds over the past 45 days. True North said it planned to distribute a portion of the cash to its limited partners after addressing the capital needs for the remaining hotel and office assets in the fund.
“This entire situation is distressing and unfortunate, but it seems the regulators are working toward an orderly resolution and we are hopeful there will be a majority, if not total, recovery of the dollars currently at risk,” the firm stated in its email.
“This entire situation is distressing and unfortunate”
True North in an email to investors
“You don’t get punished for being transparent,” the unnamed market resource remarked. “But where you get into trouble is if you go into the bunker and don’t talk to anybody, and then come out days later and say, ‘Actually, we lost $30 million, sorry’. That’s the worst thing you could do.” The source said he was aware of multiple managers getting in touch with their investors to confirm they had no exposure to SVB and one firm that put out a letter indicating that it had examined the letters of credit for all of its tenants to make sure none of the letters had been backed by the bank.
“They went really deep in their analysis of their exposure and then told investors, ‘This is where we think we have exposure’,” the source added. “That’s good investor communication.”