During the latter part of 2022, larger U.S. banks stepped back from financing commercial real estate deals. The reasons for this included the surge in interest rates, heighted regulatory oversight and concerns over increased exposure to the asset type. The result? Smaller, regional banks stepped in to provide CRE instruction and investment capital.

According to a recent CBRE analysis, Silicon Valley Bank’s and Signature Bank’s collapse is turning the focus on these regional banks, and their commercial real estate exposure. The CBRE insight pointed out that, according to the Federal Reserve, commercial real estate loans comprise 43% of smaller banks’ assets.

On the one hand, this shouldn’t be a cause for huge concern. For one thing, much of the debt is tied to multifamily, which has relatively healthy fundamentals. Another is that even with such exposure, deals have been underwritten at more conservative LTVs than they were before the Global Financial Crisis. Finally, CRE valuations have expanded – by 42% for multifamily and 14% for office. Even with higher cap rates, this offers a cushion.

On the downside, tight credit markets means that debt capital is scarcer and more expensive for commercial real estate investors. CBRE analysts point out that tight credit conditions could lead to an economic slowdown.

Additionally, according to a Seeking Alpha article written by EPB Macro Research founder Eric Basmajian, multifamily is only one debt holding. Smaller banks have a high exposure to non-residential property debt, especially office buildings. Those office buildings have been experiencing high vacancy rates. This could be a problem as debt on these properties matures.

Another issue faced by smaller banks has been deposit outflows, especially in the wake of the SVB and Signature Bank failures. Many of those deposits are heading to allegedly safer investments, with higher yields. In his article, Basmajian indicated that such outflows are making it harder for smaller banks. They might struggle to grow their lending areas and could face deleveraging.

As such, “small banks appear to have outsized exposure to highly impaired office buildings,” Basmajian noted. Because of this, small banking lending standards and availability should be monitored, as they “are the lifeblood of credit to the private economy,” Basmajian said.