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Bank CRE Loan Concentration Risks Prompting Increased Regulator Scrutiny

Several Hundred Banks Could Exceed Federal Regulators Ratio Guidance
June 22, 2016
Federal banking regulators are closely monitoring real estate loan performance as banks have stepped up their commercial real estate and multifamily lending in the last several years. After another quarter this year of strong growth, many analysts also are beginning to believe risk related to CRE lending has also increased.

Last December, federal banking regulators put banks on notice that they were going to be taking a closer look at CRE loan concentrations. Despite that, banks continued to pump up their CRE lending in the first quarter buoyed by continued strong property fundamentals.

Banks further increases their CRE lending after turbulence hit the CMBS market and as CMBS lending has fallen off in general. The balance of loans held in commercial mortgage-backed securities continues to decline and has now fallen by one third since it peaked in 2007, as more CMBS loans are paid-off and paid down than are originated.

"The amount of commercial and multifamily mortgage debt outstanding continues to grow at a strong clip," said Jamie Woodwell, the Mortgage Bankers Association’s (MBA) vice president of commercial real estate research. "Bank holdings and multifamily loans backed by Fannie Mae and Freddie Mac drove growth during the quarter."

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In the first quarter of 2016, banks and thrifts saw the largest increase in dollar terms in their holdings of commercial/multifamily mortgage debt - an increase of $26.4 billion, or 2.5%.

The questions analysts and regulators are now asking are: How much is too much? And what does it mean for bank CRE lending for the remainder of the year.

A Sketch of CRE Loan Concentration Risk


Using first quarter 2016 Federal Deposit Insurance Corp. data for insured domestically based banks, CoStar News took a look at CRE loan concentrations among banks.

Last December when federal banking agencies issued guidance on sound risk management practices for concentrations in CRE lending, one particular focus was on exposure to CRE and multifamily loans dependent on cash flow. Regulators exclude CRE loans backed by owner/occupied properties.

Banks with the following ratios were deemed worthy of further supervisory analysis:
  • Total reported loans for construction and land development (C&D) that represent 100% or more of a bank's risk-based capital; or
  • Total CRE/multifamily loans excluding owner occupied that represent 300% or more of the bank's total risk-based capital.

    Bank regulators said that their supervisory evaluations wouldn’t be based on numbers alone but would be mitigated by the overall strength of a bank’s lending and risk management practices. Those mitigating factors were not disclosed and could not be taken into account in CoStar News’ analysis.

    Based on FDIC numbers alone at the end of the first quarter of 2016 for C&D, nonresidential and multifamily lending, there could be more than 400 banks that had exceeded the FDIC's C&D or total CRE lending concentration ratios. About 30 banks exceeded both ratios.

    These 400-plus banks held total assets of $487.73 billion and had outstanding CRE loan balances (excluding owner/occupied) of $175.53 billion.

    Federal banking regulator concerns are that such banks carry disproportionately more risk than the other banks that fall below those ratios. CRE loans made up 47% of the total lending of the banks likely above guidance ratios but only 8% of the other banks that are likely under the ratios.

    The smaller group of banks has a total of $3.63 billion set aside for loan loss allowances or $8.8 million/bank on average. The banks in the larger group have set aside an average of $20.5 million/bank.

    Of the banks with high CRE concentrations 5.8% were unprofitable in the first quarter whereas only 4.9% of the larger group reported net losses.

    Banks that exceed federal guidance ratios for the most part believe that they manage credit risk closely in their loan portfolios and use a variety of policies and procedures to achieve and maintain their asset quality objectives.

    When federal regulators don’t agree, they are not shy about stepping in. In what appears likely to be the first public action resulting from the tighter fed scrutiny, last month, Carver Federal Savings Bank entered into a formal written agreement with the Office of the Comptroller of the Currency calling for preparing a three-year strategic plan to address federal concerns, including a written plan for managing its CRE concentration risk.

    As of March 31, New York-based Carver Federal held $335 million in C&D, non-farm non-residential and multifamily loans not counting owner/occuppied, 57% of its total loans outstanding. That amount equaled 454% of Carver Fed’s tier one (core) capital plus its tier 2 risk-based capital. The savings bank lost $997,000 in the first quarter.

    Lenders Turning More Conservative


    Because of such federal scrutiny, bank manager’s risk posture toward CRE lending may be becoming more conservative, Rian M. Pressman, primary credit analyst at S&P Global Ratings, wrote in a report last month.

    “For example, banks may become more cautious in lending to CRE investors in markets directly exposed to the depressed oil and gas industry. This could include parts of Texas, North Dakota, Oklahoma, Louisiana, and Pennsylvania,” he wrote. “We believe multifamily, retail, and industrial properties in energy regions may also be similarly affected over time.”

    Kroll Bond Rating Agency in a note this month said that banks could see increased incidence of charge-offs and non-current loans, but overall it expects the loan performance at U.S. banks to remain solid. That said though, the credit performance of sectors such as C&D and multifamily mortgage loans “are quite literally too good to be sustained for an extended period,” Kroll analysts said.


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