Note: This article was edited on March 16 to update how Origin is protecting its cash deposits.
It has been about 15 years since the U.S. experienced a bank panic, and many are wondering if Silicon Valley Bank’s failure is just the first domino to fall in a new crisis. While it might be an isolated episode, we wanted to update our investors on the actions we are taking to mitigate risk and to scrutinize our banking and lending relationships as this situation unfolds.
How We Took Action to Protect Our Cash Deposits
The majority of Origin Funds’ cash deposits are held at Wintrust, a Chicago-based regional bank that reports healthy liquidity metrics. We have thoroughly reviewed the bank’s recent public filings, and to further protect those deposits, we quickly transferred 77% of Fund cash into short-term U.S. Treasury bills. The remaining cash will be deployed over the next 15 to 30 days to support portfolio investment activities. Also, we are setting up a system whereby up to $100 million of our deposits at Wintrust and other institutions will be protected by FDIC insurance. This is optimal risk management and protects our investors and our business.
We requested additional information on Wintrust’s solvency, diversification and risk management on a call with Wintrust President Tim Crane, who followed up with additional details on its liquidity and diverse deposit base—including no direct exposure to cryptocurrency.
Because investments are predominantly capitalized with a combination of debt and equity, commercial real estate is susceptible to interest rate risks. That’s why at Origin, we have employed an interest rate hedging strategy. Last year, as interest rates rose, this strategy garnered a total of $43 million in gains, including several million in unrealized swaptions. That move helped us protect our Funds from interest rate increases and even provided a material gain to our Funds as well. According to the Wall Street Journal, it was “virtually unheard of” for smaller, privately held firms to employ derivatives this way.
The Story Behind SVB and Signature
Silicon Valley Bank (SVB), which had significant exposure to the tech ecosystem, was the 16th-largest U.S. bank, with assets of $200-plus billion, of which 56% was invested in fixed-rate, long-term securities with an average maturity of more than six years. Its asset base tripled during 2020-21 as tech startups flush with cash chose SVB as their go-to bank. Because its loan book was not sufficient to absorb the influx of deposits, it invested in U.S. Treasury bonds and mortgage-backed securities. However, Federal Reserve interest rate hikes starting in 2022 hobbled the tech IPO market and put downward pressure on valuations.
Last week, SVB announced a $2.25 billion capital raise that prompted panic among its clients, who requested returns of bank deposits en masse. To meet those redemptions, SVB sold bonds at a loss, and on March 10 it failed. SVB’s lack of diverse deposit bases, along with a failed strategy of borrowing short and lending long, contributed to its collapse. Signature Bank, a regional bank that became a leader in cryptocurrency lending, was taken over on Sunday, making it the third-biggest bank failure in U.S. history. While the individual circumstances of each bank don’t necessarily signal the initial contagion of a broader crisis, the situation requires us to analyze the financial health of our lending and banking relationships and their impact on real estate markets.
The Impact on Multifamily Real Estate
Near term, the demise of SVB and Signature could result in tighter underwriting for credit facilities. Regional and community banks, which provide smaller real estate developers key access to the credit market, could be more reluctant to originate new loans—especially over the next quarter as they take stock of their liquidity.
A longer-term result could be lower levels of multifamily housing supply to meet demand two or three years from now. This year will set a new high for multifamily deliveries; but according to a 2022 study by the National Apartment Association and the National Multifamily Housing Council, the U.S. needs to build 4.3 million more apartments by 2035 to meet demand for rental housing—that’s roughly a 20% increase over current stock. The Federal Reserve’s monetary tightening, coupled with a potentially constrained credit environment, could result in more favorable supply and demand dynamics for multifamily investing after the 2023 supply is absorbed.
Floating rate borrowers in the multifamily space may have to reset interest rate hedges at costly premiums to extend maturing loans, and rising rates may put downward pressure on refinancing proceeds. Both of those situations would create the need for new capital, which we believe could create various investment opportunities.
Multifamily, unlike other asset classes, has additional sources for financing via Freddie Mac, Fannie Mae and HUD, which may continue to lend while banks, insurance companies and debt funds may limit their lending activities if a banking liquidity crisis unfolds.
Determining the Health of our Lending Relationships
Origin’s Funds currently have construction loan commitments totaling $1.3 billion still to be funded as projects progress through development. The viability of the financial institutions that originated these loans is paramount. Receivership of any of these banks would disrupt our development schedules while replacement refinancing is secured. As such, we are employing additional scrutiny and analysis. In the two charts linked below, we scrutinize the banks’ liquidity and the quality of their assets using a series of key performance indicators (see definitions here).
Preferred equity: Of our total construction debt, $526 million (40%) is associated with construction financing for projects in which the IncomePlus Fund is invested in a preferred equity position (see chart). The preferred equity positions are well protected, as the Fund’s last-dollar exposure was originated at a loan to cost of roughly 81%, allowing for a buffer of 19% of common equity. Most of the financing for this portfolio is provided by regional or community banks; however, any potential disruption would likely be absorbed by external common equity holders that sit in the first-loss position.
Common equity: The remaining $780 million of construction debt is originated on projects where Origin Funds (Growth Fund IV, IncomePlus Fund, QOZ Funds I and II, and one sidecar) are invested in the common equity position (see chart). Of these construction loans, 35% were originated by larger banks considered systemically important financial institutions receiving a greater level of scrutiny by bank examiners. Our community bank lenders have recently reported strong liquidity metrics.
Growth Fund IV and IncomePlus Fund have loans totaling approximately $125 million from PacWest bank. PacWest made headlines as its stock price fell roughly 43% over the past week but rallied as of early today, and its ratios are not triggering alarm bells. However, we will continue to monitor its performance.
While most of our lenders have what is typically considered a healthy loan-to-deposit ratio, we have flagged several to follow up on with further research. All report a low percentage of non-performing loans and have adequate reserves to address loans that might become problems. No bank has invested more than 33% of its assets in marketable securities, and unlike SVB, none appears to have invested significantly in long-term bonds susceptible to interest rate increases.
Protecting Our Funds, Monitoring Our Relationships
There are many aspects of this situation that are impossible to control, and a full-fledged bank panic could result in diminished liquidity metrics for these banks. We are performing further analysis of several lenders, but as of today, we do not believe there is significant risk exposure. As risk managers, our priority is to protect and growth the wealth of our clients. We will continue to monitor our lending relationships closely and to take necessary action as this situation unfolds.