Feds Want More Emphasis on CRE Risk Management

Federal regulators are warning banks and thrifts with high concentrations of commercial real estate loans to increase their risk management practices and to make sure they are holding enough capital.

The regulatory guidance issued last week is in response to concerns that hundreds of small and midsized banks are accumulating large portfolios of CRE loans.

Even though CRE markets have improved over the past few years and appear to be very healthy, the Federal Reserve Board and other regulators want to see some discipline now. They can still remember a severe downturn in the CRE markets (1989-92) that led to the failure of many large banks and savings associations.

"Currently, lenders are operating in a relatively benign commercial real estate environment," Fed governor Susan Bies said. "However, given the historical cyclicality of commercial real estate markets, supervisors expect to see lenders with high and increasing concentrations in this area focus more intently on managing their risks."

The guidance establishes thresholds for determining when a lender has a high concentration of construction and commercial property loans. The regulators estimate 1,700 to 2,000 banks have CRE exposures that exceed the thresholds.

The guidance also reminds bankers that they may need to maintain capital at levels well above minimum requirements, "depending upon the level and nature of the CRE concentration."

America's Community Bankers executive president Robert Davis expressed concern that the thresholds could be viewed as limits and inhibit CRE lending. He also is concerned that the statements on capital are "vague" and provide little guidance to examiners or bankers.

"It is open-ended and left up to the examiners to determine the appropriate capital cushion," Mr. Davis said.

A Fed spokesman pointed out that guidance generally is not as specific as a regulation and the regulators are seeking input on the guidance during a 60-day comment period.

Under the guidance, a portfolio of land acquisition loans and loans for the development and construction of commercial and one-to-four family projects that exceed or are rapidly approaching 100% of equity capital is considered a high concentration.

Multifamily and commercial property loans (along with land and construction loans) that exceed 300% of capital are considered a high concentration.

The regulators decided to exclude CRE loans secured by owner-occupied properties from the threshold test, according to the guidance, "because their risk profiles are less influenced by the condition of the general CRE market." The Mortgage Bankers Association welcomed that decision. "We are encouraged by that breakout," said MBA senior vice president Gail Cardwell.

The SVP for commercial/multifamily lending said the guidance is definitely aimed at community banks, which are important CRE lenders in their markets. "We are working with our bank institutions on evaluating the thresholds," Ms. Cardwell said.

Back in September, Fed governor Mark Olson raised concerns that CRE lending represented essentially all the asset growth at community banks (less than $1 billion in assets) in 2003 and 2004. And CRE lending by community banks accelerated in 2005, accompanied by declines in securities holdings, home equity and other consumer loans.

"This pattern of sustained and one-dimensional growth naturally raises question about potential concentrations in CRE loans," Mr. Olson said.

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