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The Current Liquidity Situation: Panic in the Streets? Or Correction?

Revere Capital provides stable contractual income through a disciplined investment approach.

Is liquidity in the finance market in crisis or correction? Jeff Salladin, Managing Director at Revere Capital says don’t panic yet.

This past year hasn’t been kind to traditional lenders or entities hoping to borrow from them.

Even before the collapse of Silicon Valley Bank, Signature Bank, Credit Suisse and First Republic Bank, traditional lenders were pulling from issuing commercial real estate loans. Not helping the situation? The Federal Reserve’s ongoing Effective Federal Funds Rate hikes. In addition to less debt, the debt that is available costs more.

Unsurprisingly, this has constrained debt origination. Newmark’s Q2 2023 Capital Markets Report said that CRE debt origination activity was down 52% year over year during the first half of 2023. “The bigger issue is that the small and regional bank lending engine that has driven the CRE market is rapidly slowing, with no clear replacement,” the report noted.

CBRE also weighed in. The CBRE Lending Momentum Index in Q2 2023 fell 5.4% from Q1 2023 and 52.2% from Q2 2022.

To look at the headlines, one might think that the commercial real estate sector – and the banks that help fund its projects – is headed for a complete liquidity meltdown. The truth, however, is less dramatic. The banking and CRE industries are undergoing a correction, not a crisis. But rather than a natural, cycle-driven correction, the current one was forced through the Black Swan event we know as the COVID-19 pandemic.

A History Lesson

Let’s get one concern out of the way. The banking system isn’t on the verge of collapse. We aren’t facing another Great Financial Crisis and its attendant credit freezes.

The issues plaguing failed and troubled banks today involve risk management, overdependence on bond investments and a lack of specific oversight. This is a far cry from the terrible loan practices, delinquent debt and massive foreclosures that generated the GFC. Banks’ current problems include unrealized losses, lower asset values, and higher interest rates. These problems will work their way through the banking system over time. Banks will be ready to lend once again.

And remember that it wasn’t long ago when money was ridiculously cheap to borrow. 

In August 2010, the Effective Federal Funds Rate was near zero. The Fed cut its EFFR to encourage lending. This metric bounced along the bottom for a handful of years before rising to about 2.4% in the middle of 2019. Less than a year later, a Black Swan event forced the Fed to reverse course again.

Pushed by the Pandemic

A Black Swan event is unpredictable, characterized by its rarity and huge impact. This describes the COVID-19 pandemic perfectly.

The business closures, work-from-home policies and event cancellations launched in March 2020 triggered a rapid economic downturn. It also forced “a desire to hold deposits and only the most liquid assets,” according to Brookings. This disrupted financial markets.

The Fed stepped in by

  • Slicing the EFFR to a range of 0% to 0.25% with promises to keep rates near-zero until the economy recovered
  • Resuming its large purchases of mortgage-backed securities and U.S. Treasury bonds (known as quantitative easing, or QE), which it had done during the Great Recession

The economic downturn was short-lived. And the almost-free money spurred the CRE industry to borrow massive amounts from late 2020 through early 2022. According to Trepp, the issuance of CMBS in 2021 stood at $109.12 billion, a 95% increase from 2020. Trepp also pointed out that the $862 billion in CRE loans originated during 2022 set “a record for the largest amount of CRE debt originated each year.” Much of this debt was interest-only and short-term. The assumption was that when the debt matured, it could be refinanced with fixed-rate loans carrying reasonably low-interest rates. 

That could have happened had supply chain disruptions and flush-with-cash households not led to high inflation rates.

Crisis versus Correction

Here’s where we are now.

The Federal Reserve raised interest rates 11 times since March 2022, from near-zero to 5.25%-5.5%. The short-term, interest-only debt issued in the halcyon days from late 2020 through early 2022 is maturing. Traditional lenders have considerably tightened lending requirements for commercial real estate projects. This means that refinancing the debt is more complicated – and costlier.

So, are we in trouble? Not necessarily. The current situation isn’t optimal. But it’s not on the brink of collapse, either. What we’re experiencing now is a pandemic-forced correction. Banks and commercial real estate will face painful but short-term obstacles. But similar to the wild days of 2020-2022, the current situation isn’t permanent. Banks will lend again. And interest rates will reach a more sustainable level.

For more information on sourcing capital for CRE projects, contact Jeff Salladin, Managing Director at Revere Capital at [email protected] or visit their website at reverecapital.com 

Certain information herein reflects the opinions, estimates and projections of Revere Capital, an Investment Adviser registered with the U.S. Securities & Exchange Commission. All information provided is for informational purposes only and should not be deemed investment advice or a recommendation to purchase or sell any particular security, and no representation is made that expectations will be achieved. The opinions contained herein are based on what Revere Capital believes to be reasonable and accurate information that may have been provided by industry participants, research and analytics providers, and other primary and secondary sources.