Moody’s Investors Service made a significant move on Monday, issuing credit rating downgrades for over two dozen U.S. banks. Notably, this action did not come as a surprise for Matt Windisch, the Executive Vice President at Kennedy-Wilson. According to him, Moody’s decision to lower debt ratings for various small and medium-sized banks only reaffirms what is already known about the struggling commercial real estate market.
Moody’s primarily cited “profitability pressures” and the expected decline in asset quality as reasons behind their rating actions. Additionally, six major U.S. lenders are now under review for potential downgrades.
Windisch believes that the current pain experienced by landlords and banks due to stress within the commercial real estate sector is mostly driven by interest rates. However, he acknowledges that if a recession were to hit, the consequences would be much more severe.
In June, Kennedy-Wilson made a significant move by privately acquiring a $5.7 billion construction loan portfolio from PacWest Bancorp. They purchased the entire pool of construction loans and future funding commitments at approximately 95 cents on the dollar. The majority of these loans pertain to multifamily properties and student housing, with an average term of two years from purchase to maturity.
Kennedy-Wilson sees a tremendous opportunity to expand their current commercial loan portfolio of around $7 billion in the coming years. As shocks from interest rate fluctuations reverberate throughout the commercial real estate industry, the firm aims to double its loan portfolio size.
Looking ahead, Windisch states that Kennedy-Wilson is actively seeking other opportunities in the market. However, they are likely to focus on acquiring loans for multifamily and student housing projects. Windisch also mentions that their reliance on funding from sovereign wealth and insurance companies sets them apart from banks tied to the U.S. banking industry.
Despite their growing activities in the lending space, Kennedy-Wilson remains committed to their core business of multifamily and student housing. The recent acquisition of PacWest assets has further strengthened their position in this market, extending their lending platform nationwide.
Distressed Multifamily Properties Highlight Capital Structure Issues
In recent times, there has been a concerning trend of landlords defaulting on or surrendering the keys to lenders for underwater multifamily properties. However, it is important to note that these properties themselves do not appear distressed. Rather, it is the capital structure that is causing the imbalance.
The collapse of Silicon Valley Bank and Signature Bank earlier this year has raised concerns about potential broader stress within small and medium-sized U.S. banks. Over the past 16 months, the Federal Reserve has been increasing interest rates from near-zero levels, resulting in rate shocks for lenders with low coupon loans and bonds. This, in turn, has led to a flight of deposits from banks to other higher-yielding opportunities.
PacWest, a bank that had been subject to speculation about its vulnerability, recently underwent a sale to Banc of California. This move was seen as a strategic decision to mitigate risks.
Moody’s, a prominent credit rating agency, announced on Monday that it would be taking rating actions against various banks due to rising asset risks. Small and midsize banks with significant exposure to commercial real estate (CRE) are particularly susceptible, given their recent expansion of lending in this sector when property values were soaring. These banks were caught off guard by the Federal Reserve’s unexpectedly swift pace of rate hikes.
Following Moody’s rating actions, the SPDR S&P Regional Banking ETF (KRE) experienced a decline of 1.7% on Tuesday. The broader market also saw a negative impact, with the S&P 500 index dropping by 0.7% and the Nasdaq Composite Index down by 0.7%. The Nasdaq Composite Index COMP fared even worse, with a 1% drop, as reported by FactSet.
It is important for banks holding distressed commercial real estate not to rely solely on potential future Federal Reserve rate cuts. Instead, they should take proactive measures to address their debt and mitigate risks.