Why Nonbank Lenders Have Gained Share as Banks Pulled Back

Nonbank lenders and debt funds have gained commercial real estate lending share because banks cut direct lending, reduced their appetite for development risk, and moved toward financing other lenders. Private credit filled the gap with customized terms and execution certainty. Banks often stay in the chain through warehouse and loan-on-loan facilities, so a rising nonbank share of originations can sit alongside continued bank capital behind the loans.

How bank retrenchment opened the door for private lenders

Nonbank lenders gain share when a bank decides that holding a commercial property loan no longer fits its capital or risk appetite while the borrower still needs the debt. Regulatory forces have pushed banks into a different role or toward the sidelines, and alternative lenders have filled the vacuum, often on terms more favorable to the lender.

Direct bank lending on commercial real estate has fallen steadily over the past decade.

After the global financial crisis, private credit supplied two things beyond the capital itself: customized terms and execution certainty. A borrower facing a retrenching bank could get a lender that shaped the structure and committed to closing, and that combination helps explain how private credit built its position.

Hedge funds and private equity funds were among the investors that moved into the gap, along with other investment firms. They filled some of the financing void left by banks.

Because share is a ratio, nonbank share can rise while nonbank dollars stay flat if bank dollars fall. A veteran reading a share chart separates two questions: how much new capital nonbanks deployed, and how much bank capital left the denominator.

In a thin market the lender sets the terms. A share gain by nonbanks shows where borrowers found capital, and it says little about whether that capital was cheap.

“Many savvy hedge funds, private equity funds, and investment firms stepped in to fill some of the financing void left by traditional lenders (i.e. banks).”
The Single Family Office, book by Richard C. Wilson

How a bank stays in the deal by lending to the lender that replaced it

A bank that cuts direct property lending often keeps the exposure by lending to the lender that now originates in its place. U.S. commercial banks have been shifting from direct origination toward warehouse and loan-on-loan facilities for other lenders because of more efficient capital treatment.

In a warehouse facility the bank funds a share of the loans the lender closes, and the loans are pledged to the bank while they sit on the lender’s books. A loan-on-loan facility works the same way against loans the lender holds for longer. The bank’s claim runs to the lender and is secured by the loans, while the borrower’s obligation runs only to the lender.

The nonbank earns interest on the property loan and pays facility interest on the bank’s advance, with the remaining income after other expenses providing a return on its committed equity. The advance rate and the facility pricing therefore matter to a debt fund as much as the coupon on the property loan. The worked example below puts numbers on that point.

A second path moves whole loans. Regional banks sell loans they originated to debt funds, and the borrower then deals with a fund that did not make the loan.

Both paths let a bank pullback and a continuing bank presence be true together. Counting only the name on the property loan understates the bank’s role, and counting only the bank’s direct book understates how much a nonbank lender can depend on bank funding.

Where the opening is widest: development loans and smaller banks

Development is where the shift shows up most clearly. Construction lending has become increasingly dominated by nonbank lenders seeking higher absolute returns, while banks have reduced their appetite for development risk.

The stage matters because a development loan is repaid from a building that does not yet exist. There is no in-place income to test against debt service, so the lender underwrites the budget and the takeout. A loan on a stabilized property rests on income already being collected, which is a different risk and a different buyer of that risk.

Higher absolute returns describe what the lender seeks: a larger coupon and fee in dollars. That figure is gross of any losses, so it states a target and says nothing about what the lender keeps after a problem loan.

Lending from smaller and midsized banks has also diminished, which gives other lenders room to take loans those banks would once have held.

Some market participants hold that European banks could yield share to nonbank lenders if regulatory pressure and capital constraints lead to a shift. That view is conditional, and it describes a possible direction.

Published figures for nonbank share do not line up, and the reason is the measure. In the latest industry data cited for the U.S., nonbank lenders account for less than 40 percent of commercial real estate debt origination. Estimates of their share of the commercial mortgage market run from below 5 percent a decade earlier to at least 25 percent more recently.

The first number counts new loans made in a period. The second is a market share whose basis is not stated. A ceiling on origination share and a floor on market share can both hold, so the two figures do not contradict each other.

The base matters as well. The domestic commercial mortgage market is $5.7 trillion, and banks hold about half of it. The other half is shared by nonbank lenders and other holders such as life companies and CMBS investors.

That arithmetic caps the story. With banks near half, a nonbank share of 25 percent leaves the remaining quarter of the market to those other holders.

Balances turn over only as loans mature or prepay, so a share of originations can move faster than a share of outstanding loans. A gain in the share of new lending reaches the balance sheet of the market gradually.

Worked example: a debt fund’s return on a $10,000,000 loan when the bank advance shrinks

A hypothetical debt fund holds one $10,000,000 floating-rate bridge loan for one year. The borrower pays 10 percent interest, and the fund keeps a 1 percent origination fee. A bank warehouse facility funds part of the loan. Both cases use the same loan, the same fee and the same one-year period. Operating costs and credit losses are excluded, so the result is income after bank interest and before those items.

Borrower interest is $10,000,000 multiplied by 10 divided by 100, which is $1,000,000. The fee is $10,000,000 multiplied by 1 divided by 100, which is $100,000. Income before bank interest is $1,000,000 plus $100,000, or $1,100,000, in both cases.

Base case: the bank advances $6,000,000, a 60 percent advance rate, at 6 percent. The fund equity is $10,000,000 minus $6,000,000, or $4,000,000. Bank interest is $6,000,000 multiplied by 6 divided by 100, or $360,000.

Income after bank interest is $1,100,000 minus $360,000, or $740,000. Dividing $740,000 by $4,000,000 and multiplying by 100 gives an 18.5 percent return on fund equity.

Stressed case: the bank cuts its advance to $4,000,000, a 40 percent advance rate, and raises its price to 8 percent. The fund equity is $10,000,000 minus $4,000,000, or $6,000,000. Bank interest is $4,000,000 multiplied by 8 divided by 100, or $320,000.

Income after bank interest is $1,100,000 minus $320,000, or $780,000. Dividing $780,000 by $6,000,000 and multiplying by 100 gives a 13 percent return on fund equity.

The stressed case needs $6,000,000 minus $4,000,000, or $2,000,000 more fund equity. Dollar income rises by $780,000 minus $740,000, or $40,000, because the smaller bank balance costs less interest even at the higher rate. The return on equity falls from 18.5 percent to 13 percent, a drop of 5.5 percentage points.

The extra $2,000,000 of equity earns $40,000, which is $40,000 divided by $2,000,000 multiplied by 100, or 2 percent. The borrower pays the same in both cases, and the fund’s return changes because the bank’s advance and price changed. That is the channel through which a bank pulling back from a warehouse line reaches the pricing a debt fund can offer.

Mistakes that distort the bank-to-nonbank story

Reading nonbank origination as proof that bank capital left the transaction confuses the property loan with the lender’s funding. A bank facility can sit behind the nonbank, so the borrower’s lender is a nonbank while part of the money is bank money. Correct analysis tracks the borrower’s obligation and the lender’s own borrowing as two separate claims.

Comparing a share of new originations with a share of outstanding balances as if they were one measure produces false conflicts. A ceiling of less than 40 percent on origination share and an estimate of at least 25 percent for market share are consistent, because one counts a period’s new loans and the other counts a market whose basis is unstated.

Treating a loan purchase as a new origination confuses a transfer of ownership with the creation of credit. A bank-originated loan sold to a debt fund changes the holder and leaves the origination with the bank.

Treating the borrower’s coupon as the fund’s equity return drops both the funding cost and the equity denominator. In the worked example the same loan returns 18.5 percent on $4,000,000 of equity and 13 percent on $6,000,000, and the rise in dollar income to $780,000 is no sign of a better result. Return depends on the capital committed as well as on income retained.

Treating higher absolute returns in development lending as higher risk-adjusted returns skips the loss side of the ledger. The absolute return is the coupon and fee the lender targets, and the return actually earned is that figure minus whatever the loan costs the lender in default and workout.

Does the share measure new originations or outstanding balances? The denominator decides whether the claim describes a period’s lending activity or the stock of loans held.

Who holds the borrower’s repayment obligation today? That identifies the direct creditor at the point being analyzed.

Does a bank finance the nonbank lender through a warehouse or loan-on-loan facility? A facility means bank capital sits behind a loan that carries a nonbank name.

Was the loan originated by its current holder or bought afterward? A purchase changes ownership and adds no new origination.

Which deal stage explains the opening? Reduced bank appetite for development risk is specific to development and does not describe every property loan.

Which provisions make the financing customized? Named terms give the word customized an economic meaning that a label cannot.

What conditions remain before the lender must fund? Execution certainty is a feature of a particular commitment.

How much equity supports the lender’s position after its own borrowing? The equity denominator explains why the coupon on the property loan and the fund’s return differ.

What is the size of the base behind a share figure? A share of a $5.7 trillion market means little until the holders of the other shares are known.