The current regime of rising rates and inflation has slowed lending activity for many banks, who have tightened their credit standards across many asset classes. As we navigate the uncertain economic environment, commercial lenders need to take a closer look at their books and make prudent decisions on how to minimize their exposure to risk. 

We asked Yonah Sturmwind, Manager, Commercial Lending Specialty Originations, Alliant Credit Union and one of our panelists for Private Credit: A Complementary Source of Return at Connect Money’s inaugural Alternative Assets Conference on June 14 in Chicago, in an email interview about the current commercial lending environment; expectations on future loan demand; and what opportunities lie ahead. 

The Federal Reserve’s commitment to fight inflation with an aggressive tightening campaign continues to weigh on market uncertainty as borrowing costs increase and a lack of price discovery persists. 

Connect Money: How is commercial real estate financing responding to a changing interest rate environment? While there is plenty of debt capital available waiting to deploy, are fewer borrowers willing to transact unless they have to?  

Yonah Sturmwind: The Fed’s campaign of aggressive tightening has, to no surprise, caused many ripples throughout the commercial real estate finance world. As a lender who is active in the market, we have honed in on a well-defined box of transactions to pursue. We find there is competition in the market for transactions that are of similar characteristics.  

One of the primary reasons for the lower volume of transactions is due to buyers and sellers both taking in the current climate. The disparity between bid and ask has resulted in fewer transactions, but for the transactions that are executed there has generally been a compromise on pricing. Additionally, increased rents have to some degree offset interest rate increases. It is notable that many sellers are sidelined until additional clarity comes to light regarding interest rates; those sellers are only transacting if forced to by a loan maturity or other required exit. And the longer we are in this high interest rate environment, the more maturities will force sellers’ hands. Once that happens, the market will enter a period of true price discovery.   

It’s well documented that the CRE sector is facing a wall of refinancing. In a worst-case scenario, a severe tightening in credit conditions will make it difficult for investors to refinance.  

Connect Money: Do you expect lending standards to get tighter?  

Yonah Sturmwind: We do expect that in general lending standards will be tighter than at the height of the market, in particular for certain asset classes. Those tightening standards are typically shown as increased debt service coverage ratios (DSCRs), constrained debt yield thresholds, lower leverage, shorter interest-only periods, and more rigorous credit requirements.  

That said, in general, underwriting standards these days have not been as loose as they were prior to 2008. Banks and other lenders have generally held better to their credit requirements, which is likely to mean that a pullback in lending in 2023 is likely to be less severe than that of the Great Recession. The continued concerns around the banking world and access to liquidity will be another concern for refinancing as banks may pull back from lending in order to maintain liquidity.   

The most frequently cited reasons for tightening standards include an expected deterioration in property values, a reduction in risk tolerance, and a deterioration in credit quality of banks’ loan portfolios. 

Connect Money: Do you expect loan demand to weaken? What opportunities do you see in commercial real estate lending (regions, sectors) as we move through the second half of the year? 

Yonah Sturmwind: There is a natural trend that when the economic outlook becomes more fraught, traditional lenders pull back. This trend will likely open opportunities for non-bank lenders such as private equity firms and debt funds to enter the market upstream from where they were previously. Banks, credit unions, and other more traditional lenders are still active in the market but may also opt to work with non-bank lenders on facilities and A-note financings.  

On top of that, there are still macro trends benefiting some asset classes such as the lack of available housing in parts of the U.S. and the continued growth of e-commerce driving the need for more logistics facilities. We will continue to see growth in these sectors; however, it may not be on the national scale previously seen as softness is starting to appear in certain markets. Growth becomes a more localized story depending on the individual market and sub-market economies.   

Don’t miss the Connect Money: Alternative Assets Conference on June 14 in Chicago at the W City Center. Meet private credit experts like Yonah Sturmwind, Manager, Commercial Lending Specialty Originations.