Regional Banks' LTVs Have Barely Budged As The Market Has Worsened

Regional and local banks in the U.S. have left loan-to-value ratios on commercial property loans largely unchanged on average since 2018, even as the CRE market has deteriorated, according to MSCI’s U.S. Capital Trends Report.

The average LTV for regional and local banks was 66.4% in 2023, down just a tick from 66.7% five years earlier, before a pandemic and interest rate hikes brought trouble to commercial property markets. The average LTV across lender types was 62.8% in 2023.

From 2018 to 2023, all other types of lenders reduced LTVs by at least 1% as market conditions deteriorated. CMBS lenders saw the biggest change, from 62.6% in 2018 to 55.7% in 2023.

Regional banks also increased their market share in CRE, accounting for 26% of all new originations last year, up from an average of 17% during the five years preceding the pandemic. They increased their share of construction loans to 34% last year.  

Smaller banks maintain steadier lending standards than their larger counterparts, MSCI data shows, with smaller changes each year that tend to move by about 50 basis points at a time.

“You have to think about the kinds of properties that the regional banks are going to lend on,” MSCI Chief Economist for Real Assets Research Jim Costello said. “They’re not changing that. A lot of them are state-chartered to help developments in their local areas. It’s relationship banking at these small banks. You know, it’s the person across town who has a couple of small warehouses and a convenience store or strip mall kind of thing.”

In other words, small local banks aren’t lending on trophy office towers in major downtowns, where most of the trouble is found, Costello said. Just 4% of loan originations from local and regional banks since 2012 have been for central business district offices, an MSCI paper from earlier this month states.

“Small banks, they’re not making the riskiest loans,” Costello told Bisnow. “Debt funds and the large international banks were doing riskier stuff and focused on the asset classes that have the most uncertainty today.”

MSCI doesn’t pinpoint a specific asset threshold to determine what separates a regional or local bank from a national one. Instead, national banks are defined as those with a national presence, chartered by the federal government. 

One number that does help differentiate a regional bank is loan size. In 2023, the average loan among regional and local banks was $6.6M, roughly half the size of national banks’ $12.3M average.

Report after report in recent months has shown that smaller banks have the greatest amount of exposure to CRE turmoil, and Federal Reserve Chair Jerome Powell has warned about trouble for these institutions. A handful of bank failures last year and a teetering New York City Bancorp are also fueling these concerns.

But CMBS lenders and international banks have much more exposure to the riskiest loans. Since 2012, CMBS lenders have provided 27% of CBD office financing on average, according to MSCI.

“Assuming that just because a bank has CRE exposure on their books ignores the reality of the relationship-driven nature of the banking business and the differences in urban scale across U.S. cities,” the paper states.