Bracing for a CRE Backlash

We’re approaching five years since the beginning of the Covid-19 pandemic. According to the Harvard Business Review $1 trillion in Covid-era commercial real estate (CRE) loans will be coming due in the next two years. As interest rates remain high, particularly compared to those seen before the pandemic, we are also seeing high insurance and property tax rates. Vacancy rates on commercial property are also increasing as more of the workforce adopts a remote or hybrid schedule. Taken into consideration on their own, these economic factors are manageable, but all four together are troubling for borrowers’ ability to repay CRE loans that are close to maturity. So, now is the time for banks to put plans in place to cushion themselves against a potential backlash.

What’s the worst that could happen?
We’ve seen this one before. If rates remain elevated with this volume of exposure by commercial lenders, the impact on financial institutions of all sizes could be significant. With multiple factors impacting borrowers’ ability to repay, banks face higher default rates, leaving them stuck with bad assets that may need to be written off, along with collateral that will likely have to be sold at a loss. If enough banks find themselves in this position, it could catalyze consumers to start pulling deposits and depleting liquidity, potentially causing bank failures. Based on the impact of just Silicon Valley Bank, Signature Bank and First Republic Bank failing in the spring of 2023, we know that a run on banks is possible and would be catastrophic not only for the financial services industry but also for the economy as a whole.

What can be done?
Banks need to prepare now for potential losses by reviewing current and potential revenue streams. They should review current pricing on existing products and explore products that will drive the most revenue and generate deposits the quickest with the lowest cost and shortest implementation time. This is a staunch reminder that banks should consider diversifying their revenue streams and deposit bases.

The key is to monetize services that customers need and to market them in a way that focuses on convenience and ease of use. Treasury services are more commonplace and expected by most businesses. They are a great way to bring in more income from a bank’s existing commercial customers. Banks should review their existing treasury offerings and see if there are more services that could be easily added and would provide a lift to their commercial clients in terms of service and cost. They should review the appetite for these services among their commercial clients and determine if new services should be added or if pricing on existing offerings should be adjusted based the increased value of the services being offered and customer demand.

Banks can then can create an à la carte services menu to offer to their customers or to create attractive bundled pricing. Purchasing cards, wire transfers, account analysis, remote deposit capture, positive pay (which is highly needed for checks and automated clearing house due to increased fraud), digital escrow and external transfer capabilities are services that commercial clients are willing to pay for without feeling like they’re being gouged. That’s because they are saving money through efficiency gains and risk reductions. Not only will this bring in additional income, but it will also increase stickiness among high asset commercial clients.

In addition to exploring opportunities with treasury services, banks could consider partnering with technology vendors to white label products and services to avoid developing them on their own. E-signatures, digital signatures and payment protection insurance are all viable opportunities to collect more revenue while providing value to consumer and commercial customers. They could also explore revenue sources that they haven’t leveraged in the past, like rate swaps and derivative hedges, to help manage interest rate risk and stabilize earnings.

What’s the bottom line?
The full impact of inflation, higher interest rates, low liquidity and increased concentrations is about to rear its head. Banks need to be prepared, but they need to be thoughtful and really consider their customers’ needs when it comes to identifying the right sources of stability and growth. With thoughtfulness and planning, it is possible for banks to collect more income from customers and replace potential losses, while showcasing increased value and maintaining loyalty to their bank by offering new, easy-to-implement, useful and convenient services.

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