Friday, December 18, 2015

What I like to see: Agencies Issue Statement on CRE Loans

by Bill McBride on 12/18/2015 12:25:00 PM

During the housing bubble, the regulatory agencies were lax in providing guidance related to weak lending standards and high credit concentrations.  Now the agencies are being more proactive.

This doesn't suggest a problem in CRE lending, rather the agencies are trying to get ahead of future problems.

From the FDIC: Agencies Issue Statement on Prudent Risk Management for Commercial Real Estate Lending

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (the agencies) are jointly issuing this statement to remind financial institutions of existing regulatory guidance on prudent risk management practices for commercial real estate (CRE) lending activity through economic cycles.

Recent Supervisory Findings

The agencies have observed that many CRE asset and lending markets are experiencing substantial growth, and that increased competitive pressures are contributing significantly to historically low capitalization rates and rising property values. At the same time, other indicators of CRE market conditions (such as vacancy and absorption rates) and portfolio asset quality indicators (such as non-performing loan and charge-off rates) do not currently indicate weaknesses in the quality of CRE portfolios. Influenced in part by the continuing strong demand for such credit and the reassuring trends in asset-quality metrics, many institutions’ CRE concentration levels have been rising.

The agencies’ examination and industry outreach activities have revealed an easing of CRE underwriting standards, including less-restrictive loan covenants, extended maturities, longer interest-only payment periods, and limited guarantor requirements. The agencies also have observed certain risk management practices at some institutions that cause concern, including a greater number of underwriting policy exceptions and insufficient monitoring of market conditions to assess the risks associated with these concentrations.

Historical evidence demonstrates that financial institutions with weak risk management and high CRE credit concentrations are exposed to a greater risk of loss and failure.
emphasis added
The seeds for the next round of bank failures are always planted during an expansion. This statement - and strict enforcement - are important to limit future failures.