April saw 2024’s first bank failure when Republic First bank closed on April 26. The bank failed to reach an agreement with The Norcross-Braca Group, which, in September 2023 committed to invest $35 million if the bank submitted its report and scheduled required shareholder meeting.

The bank, which previously announced plans to exit its mortgage lending business, also had issues with internal controls and declining deposits. After the bank did not file the report, Norcross-Braca backed out of the deal. The bank pointed figures at its own executives, citing a “failure to maintain adequate internal controls.” Looking into the recent past, the bank’s auditor told the bank in 2022 that it had weaknesses in internal controls in the area of reporting.

Internal controls in banking help banks limit risk and protect assets by applying a systematic and policy-driven approach to achieving the bank’s objectives. The board and senior leaders are responsible for these controls. Internal and external audits and creating a culture of compliance, where doing the right thing, and speaking up about errors and omissions so they can be proactively corrected help establish the right environment for banking. Republic First was quickly acquired by Fulton Bank of Lancaster, Pennsylvania with a minimum of downtime for bank customers.

Why is mortgage lending more difficult in a high-interest-rate scenario?

In a high-interest-rate scenario, mortgage lending becomes significantly more challenging for both lenders and borrowers. Higher interest rates increase the cost of borrowing, which translates to more expensive monthly mortgage payments for prospective homeowners. This can lead to a decrease in the pool of qualified borrowers, as many individuals may find themselves unable to meet the stringent financial criteria required to secure a loan. Additionally, higher rates often dampen demand in the housing market, resulting in fewer transactions and a slower market overall. Lenders may also face higher risks, as borrowers are more likely to default on their payments when faced with elevated interest costs, prompting stricter lending standards and more cautious underwriting practices.

Commercial real estate faces ongoing challenges following COVID

The COVID-19 pandemic had lasting effects on the commercial real estate environment, particularly evident in 2024. The rise of remote work and an increased preference for flexible working arrangements led to a significant underutilization of office space. Many businesses reassessed their real estate needs, opting for smaller or more versatile office solutions, thereby reducing demand for large commercial properties. Additionally, economic uncertainties and shifts in business operations caused by the pandemic prompted companies to be more cautious about long-term leasing commitments. This resulted in higher vacancy rates and pressured landlords to offer competitive lease terms and concessions. Consequently, the commercial real estate market experienced a period of stagnation and adjusted property values to reflect the decreased demand and utilization.

Loan-to-value and the refinancing crunch

The drop in property values can further exclude prospective borrowers from the market. As property values decrease, the loan-to-value (LTV) ratio becomes a critical factor in lending decisions. Typically, banks are willing to lend up to 80% of the property’s total value. However, as property values decline, the equity that borrowers can leverage diminishes, making it more difficult for them to meet this threshold. Consequently, many property owners are now facing challenges when attempting to refinance their properties, as they may no longer possess sufficient equity to qualify for favorable loan terms. This predicament exacerbates the existing credit crunch, ultimately stifling the recovery of both residential and commercial real estate markets.

Will banks continue to close?

The bank closings in 2023 and this recent bank closing in 2024 each present unique scenarios influenced by the specifics of the banks involved and their investment strategies. While rising real estate market uncertainties and escalating interest rates increase the risk for banks heavily invested in real estate loans coming due, it is the composition of each bank’s overall loan portfolio that largely determines their vulnerability. For some banks, a high concentration of real estate loans coupled with significant exposure to volatile markets heightens their risk. Conversely, other banks may face challenges due to a diverse yet risky portfolio that includes unstable sectors or high-risk investments, such as leveraged loans or speculative ventures. The balance, or lack thereof, within these portfolios dictates their susceptibility to economic fluctuations and financial instability, ultimately influencing their likelihood of closure.

For the most part, experts are optimistic and do not anticipate sudden expansion in the market.

Overcoming barriers to financing for borrowers

When banks are unable to lend, borrowers can turn to private money lenders as an alternative source of financing. Private money lenders are typically individuals or private companies that offer loans secured by real estate or other assets. These lenders often provide more flexible terms than traditional banks, making them a viable option in challenging market conditions. Borrowers can leverage private money by showcasing the value and potential of their assets to secure funding.

Additionally, private lenders may be more willing to take on higher risks, making it possible for borrowers with lower equity or those involved in high-risk ventures to obtain the necessary capital. By forming relationships with private money lenders, borrowers can access quick and customized funding solutions, enabling them to refinance properties, invest in new projects, or maintain liquidity during economic downturns.

Contact our team if you have faced loan declines or you anticipate a challenge accessing funding for your real estate acquisition, refinance, construction, or retrofit. We will help you create a roadmap to funding and will conduct the hunt for capital on your behalf.