Concentrations in Commercial Real Estate Lending--Sound Risk Management Practices
In December 2006, The Federal Reserve Board, Federal Deposit Insurance Corp., and the Office of the Comptroller of the Currency issued final guidelines that included specific thresholds defining high concentrations of commercial real estate loans. However, the Office of Thrift Supervision issued its own guidance without the thresholds - a break that leaves banks and thrifts facing separate enforcement standards on an issue that regulators have identified as a growing risk for all institutions. Thrift banks are barred by statute from engaging in nonresidential commercial real estate lending that is greater than 400 percent of capital. Instead, the OTS released guidelines that were largely similar to those of the banking regulators but did not include thresholds or specify what constituted high concentrations of commercial real estate.
The concurring bank regulators held fast to their original thresholds, defining high concentrations as a CRE portfolio equal to 300% or more of total capital, or loans for land, land development, and construction equal to 100% or more of capital. The bank regulators did grant bankers a key concession, however, saying that they would not consider a CRE portfolio a high concentration unless holdings have increased by more than 50 percent in the past three years. That effectively decreases the number of banks affected by the guidelines and will help regulators focus on truly troublesome banks. The Agencies also offered a concession on multifamily loans. Though such loans are still contained within the definition of commercial real estate, the regulatory Agencies explicitly said well-structured multifamily loans should be considered low-risk.
Originally opened for comment in January 2006 through April 2006, collectively, the Agencies received over 4,400 comment letters from regulated financial institutions and their trade groups on the proposed guidance. Predominantly, these comment letters expressed strong opposition to the guidance, stating that the Agencies should address the issue of CRE concentration risk on a case by case basis. The opposition also noted that there are adequate existing regulations and guidance to address CRE concentration risk.
The final guidance contains a new section referred to as "CRE Concentration Assessment" that provides that institutions should perform their own assessments of concentration risk in their CRE loan portfolios. While the final guidance does not establish a CRE concentration limit, the Agencies have retained high-level indicators to assist examiners in identifying institutions potentially exposed to CRE concentration risk. Commenters were concerned that the proposed thresholds would be perceived by examiners as limits on an institution's CRE lending activity. The Agencies believe that the final guidance addresses these concerns by placing the emphasis on the institution's own assessment of its CRE concentration risk rather than on the proposed concentration thresholds.
In the final guidance, the Agencies have responded to these concerns by specifically stating that the guidance does not establish any specific limits on institutions' CRE lending activity. Institutions are reminded that they should hold capital commensurate with the level and nature of the risks to which they are exposed.
The final guidance is very similar to the proposed guidance issued earlier in 2006. Other changes to the proposed guidance were written to provide clarification to financial institutions.
For more information on this final joint guidance and the actual text, please visit:
http://www.fdic.gov/news/news/press/2006/pr06114a.html
- Andrew R. Sangalang, Berry, Dunn, McNeil & Parker