April 24, 2017
EXCERPT: Banks with an over-concentration of CRE loans on the books have come under scrutiny from regulators who are requiring them to adopt more prudent risk management strategies while balancing out their portfolios.
An over-concentration of CRE loans in some banks portfolios is placing them under the microscope in terms of more stringent regulations.
The commercial real estate (CRE) lending market has seen major improvements and recovered well from the financial debacle nearly a decade ago, thanks in part to the low-interest rate environment we’ve been immersed in since. However, concerns have surfaced regarding the potential over-concentration of banks’ CRE volume, with objections being voiced by the U.S. Office of the Comptroller of the Currency (OCC).
Heightened Growth in CRE Concentrations Placing Banks Without Sound Risk Management at Increased Risk
CRE lending has seen rapid growth over the recent past, with high demand cited as the biggest driver, particularly for multi-family, retail, and office buildings. Yet many banks decreased the active management of their CRE concentrations and conducting valuation practices over recent years as real estate prices began to normalize and regulators began shifting their focus on issues aside from CRE. Without being consistently asked by regulators about the soundness of their stress testing programs on their CRE concentrations, many bankers believed there was decreased need to dedicate the necessary time and resources to such risk management.
Although the focus on risk management practices was diminished, CRE concentrations continued to fortify. And now regulators are placing their focus yet again on the CRE concentration management and testing practices of banks across the country. Such a scenario has prompted regulators to remind banks of the necessity to implement prudent management practices to manage CRE risk.
Regulators Warning Banks of Emerging Risks Associated With Over-Concentration of CRE Loans
According to a study conducted by the U.S. Government Accountability Office (GAO), 85 percent of the banks that failed in the years following the recession in 2008 had pursued aggressive CRE growth strategies and were subject to weak underwriting standards. Such a lethal combination resulted in high CRE concentrations that exposed these banks to the long-running financial downturn that started in 2007.
Growth in multi-family construction has been one of the driving factors in an increased demand for CRE loans.
The OCC has already been instructing several banks to put a halt on originating commercial loans until an appropriate risk management framework has been established.
Regulators have warned banks on the potential perils associated with CRE lending and are reminding them of the necessity of actively managing such risks including tightening underwriting standards as competition increases.
The situation is somewhat reminiscent of the banking industry back in 2006 before the recession hit, when regulators warned of an imminent downturn in commercial real estate and encouraged financial institutions to implement prudent risk management practices associated with their CRE loans.
Regulators are again encouraging banks to continue with prudent underwriting discipline and risk management practices regarding their CRE lending activity. More specifically, banks should regularly review their CRE policies to ensure consistency with their appetite and tolerance for risk, maintain risk management practices that support their loan portfolio composition, and uphold capital levels that coincide with their CRE concentrations risk.
Sound Loan Sales Can Help Banks Rebalance Their Portfolios and Better Manage Risk
Successful CRE lending is heavily based on the establishment of a vigorous risk management structure that involves sound underwriting practices. Yet even with such practices CRE concentrations may have become too high at some banks over recent years, putting many banks in a risky position as their CRE concentrations increase.
With that, banks have been facing harsh criticism from the OCC to restructure their CRE loan profiles and risk management strategies. Financial institutions in this position would be well advised to consider a loan sale as a means of rebalancing their portfolio. At Garnet Capital, we can help facilitate such lucrative loan sales.
Browse our white papers today to discover how partnering with a seasoned loan sale adviser can help banks control risk while optimizing loan portfolios.