Increased regulatory scrutiny over commercial real estate concentrations could factor into more banks' decisions to sell.

Federal regulators warned in December that CRE concentrations could lead to "greater risk of loss and failure." Recently, there have been rumblings that regulators will press banks with high levels of commercial real estate loans to hold more capital.

Those developments contributed to — and may have accelerated — Suffolk Bancorp's decision to sell itself to People's United Financial in Bridgeport, Conn., Howard Bluver, Suffolk's president and chief executive, said. The $2.3 billion-asset Suffolk, which had recently tapped the brakes on CRE lending so it wouldn't have to raise capital, addressed the issue promptly by selling to a much bigger, and more diversified, company.

"It's like a treadmill," Bluver said of the regulatory environment. "You grow and your performance metrics get better, but then you have to raise capital, so performance metrics are set back. By partnering with someone larger, we are taking the shackles off."

Others could follow the Riverhead, N.Y., company's lead, industry observers. Still, real estate concentrations are likely to be among a multitude of reasons to sell rather than serving as the single, driving cause.

"It could be a catalyst" for sellers, said H. Rodgin Cohen, senior chairman at Sullivan & Cromwell.

"Everyone is worried about CRE concentrations, and it's absolutely because of the regulators," said Robert Kafafian, president and chief executive of Kafafian Group. "Many banks would look at that line of business and say it's legitimate and works for them and is collateralized, if it's well managed. But anytime the regulators see concentrations, they don't like it."

Regulators are watching banks with CRE books that are equal to more than 300% of total risk-adjusted capital; those that are significantly over that amount may need to hold more capital, industry experts said.

Such scrutiny could force management teams, in certain circumstances, to choose between reducing the size of their institutions' CRE portfolio or raising an "almost prohibitive" amount of capital, Cohen said. "There may not be an easy fix, so then that encourages mergers," he added.

Banks that let their CRE portfolios to run off over time could struggle to replace those loans with good earning assets, particularly in a low-rate environment, Cohen added. Some banks are looking to do just that by shifting more resources to commercial and industrial loans and consumer lending, Kafafian said.

Other banks are diversifying through geographic expansion or the addition of national lending platforms. For instance, Berkshire Hills Bancorp in Pittsfield, Mass., agreed on Monday to buy First Choice Bank in Lawrenceville, N.J.; that deal would allow the buyer to enter Philadelphia and add a national mortgage lending business.

"Geography used to be a dirty word, but we're seeing folks jump across geographies like I've never seen," Kafafian said.

Still, it can take time before new products or business lines yield results.

Suffolk, by selling to the $39 billion-asset People's United, will gain access to more products and services, such as interest rate swaps, Bluver said. Suffolk's clients will also be able to access the Connecticut company's more sophisticated wealth management business.

The deal — valued at $402 million, or 196% of Suffolk's tangible book value — is "in the high end of recent transactions in the region," said David Bishop, an analyst at FIG Partners. Still, the pricing reflected the value of Suffolk's core deposit franchise.

"From a competitive standpoint, things weren't getting any easier for Suffolk for CRE" given competitive underwriting conditions and mounting regulatory oversight, Bishop said.

Suffolk's CRE concentrations will have a minimal impact on People's United's ratios, Jack Barnes, the Connecticut company's president and CEO, said during a conference call Monday to discuss the acquisition. Its CRE levels will increase from about 276% of capital to 283% once the deal closes.

Regulators "on a broad level want to make sure there's diversification in portfolios and concentrations are being managed well," Barnes said during an interview after the call. "That really becomes unique to each bank." 

People's United could look to pursue more deals on Long Island, where a number of other banks have high CRE concentrations. The company likes Long Island because of its strong demographics, such as high household income levels, that are in some ways more attractive than its home market of Fairfield County, Conn., Barnes said.

The company, which has made strategic hires around New York, has generated good organic growth in the market. "I think New York can gradually get to a point where someday, if I had a vision, it would be that it's the same size as Connecticut," Barnes said during the call.

People's United could also look at deals in other existing or adjacent markets, Barnes said.

The acquisition of Suffolk is roughly equivalent to a year of organic growth for People's United, though executives declined to disclose during the conference call when they expect to cross $50 billion of assets, a threshold that triggers greater regulatory scrutiny. People's United continues to "work through the process internally…to get the work done over time so that we're ready when we do cross $50 billion," Barnes said.

Subscribe Now

Authoritative analysis and perspective for every segment of the mortgage industry

30-Day Free Trial

Authoritative analysis and perspective for every segment of the mortgage industry