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Veteran investors, issuers, and lawyers are eyeing US regional banks between $10bn to $100bn in assets, looking for structured solutions to address their commercial real estate (CRE) concentration.

SRT or CRT deals could help, but face challenges, pushing banks to look at other ways to move CRE exposures off-balance sheet — such as selling CRE loans and buying back related CMBS debt.

“It is a bit more difficult to use CRT as a tool for CRE because there hasn't been a lot in the space to make people comfortable with the structure,” said Matthew Bisanz, partner at Mayer Brown. “If you were to do one, it would be fairly novel and might need to use a slightly different structure.”

SRT Issuance from large US banks failed to reach expectations last year, leading some to target regional banks as a potential source of dealflow. SRTs are a tool for banks to buy credit protection for loans on their portfolio from investors, which can reduce capital held against the loans, without actually selling them.

Because these deals don’t actually remove assets from bank balance sheets, they don’t necessarily help tackle concentration limits. In the US, banks with CRE to Common Equity Tier 1 (CET1) ratio above 300% can face greater regulatory scrutiny from the Federal Reserve and the Federal Deposit Insurance Corporation.

CRE exposure is concentrated among the smaller US regional banks. Banks with $10bn to $100bn had around 42% of their total loans tied to CRE in 2024 compared to 13% for banks with over $100bn in assets, according to Visible Alpha consensus and S&P Global Market Intelligence.

Small regional US banks with $10bn to $100bn had an aggregate CRE to CET1 ratio of around 313% last year, according to Visible Alpha consensus data. These figures were at 366% for banks with less than $10bn in assets, while banks with over $100bn in assets had a ratio of around 86%.

In the mid-sized bank range Dime Community Bancshares notably had a CRE to CET1 ratio of 925% last year, with a YoY growth of 14%. Valley National Bancorp had a ratio of 625% and a -10% YoY growth, according to Visible Alpha.

New York Community Bancorp is an outlier in the over $100bn in assets group with a CRE to CET1 ratio of around 617% in 2024, according to Visible Alpha. NYCB has been in the process of offloading some CRE loans and diversifying its balance sheet as part of a turnaround plan, after concerns about this portfolio caused a $6bn drop in its market value last year.

Tough sell

Simply selling down CRE loans, though, is likely to be expensive. Lots of CRE exposures are fixed rate, while even floating rate loans were often struck against a backdrop of tighter credit spreads, meaning an outright sale is likely to crystallise substantial mark-to-market loss.

While a synthetic credit risk transfer might avoid crystallising these losses, it doesn’t solve for concentration.

“One of the big problems is that CRE concentration is based on balance sheet assets, and CRT doesn't really remove things from the balance sheet,” said Bisanz.

“The is the main hurdle we have run into, is getting some kind of regulatory comfort that a synthetic credit risk transfer would result in a reduction in CRE concentration, not just capital relief,” he said. “I don't think we have gotten there yet.”

That points the way towards hybrid solutions for derisking CRE books.

If you are doing a transaction for CRE you might first look to do a true sale of the CRE loan and maybe financing it or buying back a portion of it, said Bisanz.

This would look like a transaction that would move CRE off balance sheet, transform it, and bring part of it back in a way that no longer counts towards the 300% limit.

“We are working on a few transactions in fairly advanced stages to that effect,” said Bisanz. “I think that is where most of the potential is right now.”

This could work if the bank has high quality CRE loans that face a smaller mark-to-market hit, or if there’s a way to negotiate with a buyer to not recognise such a significant loss.

The CRE concentration measure does not include other types of CRE-related exposures like CMBS.

“The needle to thread is, if you sold the CRE loan, and then bought back CMBS, then the bank would have the same size exposure, but to a different risk profile,” said Bisanz.

The bank could buy back a senior piece of the CRE loan and characterise it as a type of CMBS-like instrument. “That's something we've seen at some pretty advanced stages, as a solution,” said Bisanz.

This would be beneficial to investors that do not want to own all the CRE loans and to the bank which may want to retain its lending relationships.

Glenn Blasius, founder of Sacagawea Peak Consulting Services and former managing director at Christofferson Robb & Company, would like to go beyond SRTs, helping the bank plan strategically for the integration of SRTs or other capital management tools into their balance sheet.

“Sacagawea Peak will work with banks to understand and strategically integrate any capital management tools,” said Blasius “We will help understand and articulate the strategy first which will then support tactical decisions, such as the issuance of a deal.”

There are around 125 US banks with assets between $10bn and $100bn, according to S&P Global Market Intelligence.

Blasius and Bisanz recognise that ways to optimise bank balance sheets extend beyond SRT, with participants exploring these cash securitisation solutions, asset sales, financing partnerships, and diversifying their investments.

If regulators can be convinced, SRT structures which reference CRE loans but re-characterise them as a different type of exposure post-SRT could help to address concentration.

Given that CRE loans can be riskier than the usual reference obligations in SRTs, strategies will require sector-specific expertise. Valuations in commercial real estate can be opaque, and require regional and asset class experience — assessing, for example, how much the refurbishment of a shopping mall would increase the future rent roll is a long way from corporate credit investing, which underpins much of the SRT universe.

This creates difficulties for agreeing on prices and structuring transactions referencing CRE loans. Delinquency metrics and restructuring approaches can also vary greatly depending on the type of CRE loan.

“There is a wide range of performance expectations for CREs as an asset class, which makes it difficult for the traditional SRT investor,” said Blasius. “Typical SRT investors are not paid to find the upside, they are fixed income investors. We hope to be able to recommend the best course of action for the bank and only then to find a transaction which works.”

CRE concern

Regulators have long been concerned about financial stability risks posed by heavy CRE exposures. The IMF, for example, dedicated a chapter to the topic in last year’s financial stability report.

Many CRE loans were issued in a low-interest rate environment and rising rates have put pressure on the sector, with property valuations dropping and debt service eating up increasing proportions of property income.

The 300% concentration rule stems from lesser-known risk management guidance passed in 2006 by the Office of Comptroller of the Currency to address CRE concentration risk. The guidance says that a bank approaching or exceeding this criterion “may be identified for further supervisory analysis of the level and nature of its concentration risk.”

In practice, this could require addressing seven different broad categories of its risk management framework.

These include board and management oversight, portfolio management, management information systems, market analysis, credit underwriting standards, portfolio stress testing and sensitivity analysis, and credit risk review function.

The actual consequences of tripping up the 300% limit unfold in private conversations with the regulator which can result in additional regulatory scrutiny, limits on further CRE lending activity, or affect a bank’s ability to undergo a merger.

Some regional banks have already been taking action to tackle CRE concentration exposures.

Last year, S&P Global downgraded five regional banks with some of the highest CRE exposures in part because stresses in CRE markets could affect asset quality and performance.

These banks were First Commonwealth Financial, M&T Bank, Synovus Financial, Trustmark and Valley National Bancorp.

This year, 19 February, S&P Global revised its outlook on six US regional banks for having improved their ability to handle CRE challenges. This included all previously downgraded banks and Columbia Banking System, which had been downgraded the year before.

Part of the improvements included reducing their CRE to CET1 ratios.

SRT improvements

Though much of this was achieved through earnings retention and the issuance of shares, some of the banks used securitisation for balance sheet optimisation — though not necessarily on their CRE books.

Valley National Bancorp completed a synthetic credit risk transfer (CRT) in June 2024 on $1.5bn of its $1.8bn auto loan portfolio, which added 20bps to its risk-based capital ratios. The offering amount for the transaction was $188m. It was structured as a credit default swap.

The same bank sold roughly $1bn of CRE loans to Brookfield last year, at a discount of around 1%. It previously sold $151m of CRE loans and $45.6m of construction loans to a related party Bank Leumi Le-Israel, at par.

Merchants Bank of Indiana, a subsidiary of Merchants Bancorp, did a CRT on 30 March 2023, placing $158m in credit-linked notes referencing a $1.13bn pool of healthcare commercial real estate loans. The notes bear a coupon of SOFR+ 1550bps.

Though this transaction achieved a reduction in risk weighted assets and benefited the bank’s regulatory capital ratios it did not directly reduce the bank’s CRE concentration

Synovus Financial also used securitisation activity last year to boost its CET1, 9fin understands.

Other mechanisms for the remaining banks included sale of low-yielding securities, partial subordinated debt redemption, reduction in short-term borrowings, pickup in earnings, limited loan growth, and modest shareholder payouts.

Over 20 US regional banks have already launched balance sheet optimisation programs in the past few years, 9fin understands. This includes some larger banks with over $100m in assets. For example, US Bancorp, Huntington Bancshares, Ally Financial, Santander Holdings USA and Western Alliance Bancorp have all issued CRTs in the last few years.

A few other notable transactions with US banks under $100m in assets include, according to S&P Global and public filings:

• Merchants Bancorp did a CRT on $543m of its multifamily bridge loans portfolio Q2 2024. The offering amount was $76m. It was structured as a credit default swap.
• Pinnacle Financial Partners did a CRT on $1.7bn of its first-lien consumer real estate mortgages portfolio Q2 2024. The offering amount was $86.5m. It was structured as a credit default swap.
• SoFi Technologies did a CRT on $2.5bn of its student loans portfolio Q4 2023. The offering amount was $289m. It was structured as a credit default swap.
• Banc of California did a CRT on $2.7bn of its single-family residential mortgages portfolio Q3 2022. The offering amount was $132.8mn. (Since PacWest Bancorp did a reverse merger with Banc of California, the CRT issuance is for legacy PacWest Bancorp). It was structured as a credit-linked note.
• Texas Capital Bancshares did a CRT on $2.2bn of its warehouse portfolio Q1 2021. The offering amount was $275m. It was structured as a credit linked note.