Much has changed in CRE lending since the last downturn. stress tests may be useful for planning purposes and to identify potential vulnerabilities. Sponsor or guarantor financial analysis, if applicable. Regulators and bank management must not become complacent or static in their approach to risk management; they must continually evolve and change as the environment changes and new risks appear. Essentials of Real Estate Finance provides the tools necessary to analyze income-producing property from the perspective of an institutional investor. "Adapting to CRE Concentration and Risk Management Guidelines" (April 2007) describes one bank's firsthand experience in incorporating the principles. The usefulness of this type of test relies heavily on the reference portfolio selected to conduct the test. Banks and thrifts must now follow federal appraisal regulations, and regulators require banks to establish an effective real estate appraisal and evaluation program to ensure independence and improve quality.3 4. Most geographic locations in the United States have not experienced serious declines in CRE markets for a number of years. The standards primarily focus on the responsibilities of the bank's board of directors for developing and issuing lending policies. Managing Commercial Real Estate Concentrations. Concentrations, as previously noted, mean higher inherent risk. The remainder of this article provides context and additional information for some of the topics addressed in the CRE guidance. See section titled “Loans in Excess of the Supervisory Loan-to-Value Limits.”. In institutions with limited or only recent experience in CRE lending, the historical perspective required to conduct this sort of stress analysis would be based on external data that may or may not be applicable. Examination Specialist, Credit Underwriting Standards and Administration. Learn if your bank is insured, view locations, track history, and more. Determining market fundamentals for each product type and geographic market where the bank has funds committed. Testing each credit in the portfolio, considering the current status of each project against the impact of the sensitivity analysis forecasts. Some analysts suggest that a major sea change has occurred in the form of greater transparency and liquidity that acts as a cushion against the deep losses of the 1980s and 1990s. The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation are jointly issuing the attached Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices (guidance). (Available data will often be fairly general in nature—losses on hotels, retail buildings, office buildings, etc.—rather than for more specific product types—suburban hotels versus downtown hotels, multitenant office buildings versus owner-occupied office buildings, etc.) Developing sensitivity analysis forecasts, such as increased vacancy rates in the market by product type, slower absorption rates, reduced sales prices, higher capitalization rates, or higher interest rates. This Guidance is based upon the principles contained in the Agencies' real estate lending standards regulations and guidelines. Examination Specialist, Not surprisingly, CRE-related loans account for a significant portion … Review of Monetary Policy Strategy, Tools, and Communications, Banking Applications & Legal Developments, Financial Market Utilities & Infrastructures. is the third leg to any successful rating system. In December 2006, the FDIC, in conjunction with the other federal banking agencies, issued joint guidance to financial institutions entitled, Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices,to reinforce sound risk-management practices regarding concentrations in CRE lending. 4 An Analysis of the Impact of the Commercial Real Estate Concentration Guidance higher than loss rates for owner-occupied loans, were significantly lower than those for construction loans. Another technique used by some banks with larger portfolios and more sophisticated internal data is to stress ratings migrations. Minimum prompt corrective action capital levels, as a result, are not typically appropriate for banks with concentrations.3Likewise, banks with a significant exposure to a particular loan type, market, or industry should incorporate the likelihood of strong correlations among the loans when determining the appropriate allowance for loan … A common delivery method is to provide lenders with a “heat map” that details management’s view of the demand for product types in each geographic market and directs lenders’ degree of aggressiveness for those products. In this case, an upward adjustment in loss rates would seem necessary to address the additional concentration risk. A well-diversified bank is, in general, better insulated against market downturns. Additionally, banks that have experienced recent, significant growth in CRE lending will receive closer regulatory review than those that have demonstrated a successful track record of managing the risks of CRE concentrations. The second component is Real Estate Law, which offers an overview of the legal issues confronting the real estate executive. This becomes increasingly important as the bank grows and more people are involved in the risk rating process. The Agencies have observed that commercial real estate (CRE) concentrations have been rising over the past several years and have reached levels that could create safety and soundness concerns in the event of a significant economic downturn. Reiteration of Interagency Guidance on CRE-Commercial Real Estate Concentrations has had limited impact on Banking Industry. • Total commercial real estate loans should not exceed 300% of capital. 3. Monitoring speculative single-family housing development can be especially challenging. Listed below are some examples of possible indicators that particular markets are at or near a peak. In particular, small to mid-siz… The Guidance reminds institutions … For example, the ADC loss history on the reference portfolio is for a geographically diverse group of loans, but the current portfolio is largely concentrated in one location. Independence in the validation process Identify the similarities or differences between the bank’s current portfolio and the historical reference portfolio, and adjust the loss rates appropriately. Various tools may be available to monitor CRE markets, depending on the size of the market. The secure Internet channel for FDIC-insured institutions to conduct business and exchange information with the FDIC. In light of the possibility of significant losses in CRE portfolios, banks with concentrations in CRE can use stress testing to assess the extent of their exposure to a downturn in CRE markets. Sound risk management strategies are … Regulatory limits for commercial real estate lending levels are at high levels for many community banks. Institutions should also consider the following items with regard to managing construction loans: An institution’s lending policies should permit only limited exceptions to underwriting standards. To ensure that risk management and lending are working in concert, the two functions must communicate. Management first needs to identify the drivers that will affect segmentation at origination and then capture those data fields on the system. In addition to the changes regarding appraisals, the federal banking agencies, along with the Office of Thrift Supervision (OTS), have established underwriting and risk management requirements.5 A pillar of these requirements is loan-to-value (LTV) limits for different CRE property types. Real estate lending represents one of the major components of credit risk at many banks. Typical loan production and performance reports by type, region, officer, etc. Recursos del seguro de depósito en español, FDIC National Survey of Unbanked and Underbanked Households, Money Smart - A Financial Education Program, Risk Management Manual of Examination Policies, Bank Secrecy Act and Anti-Money Laundering, FFIEC Information Technology Examination Handbook, Consumer Compliance Supervisory Highlights, Organization Directory and Office Contacts, www.fdic.gov/news/news/financial/2006/fil06104.html, www.fdic.gov/regulations/laws/rules/2000-8700.html, www.fdic.gov/regulations/laws/rules/2000-4300.html, www.fdic.gov/news/news/financial/2003/fil0384b.html, www.fdic.gov/news/news/financial/2005/fil9005.html, www.fdic.gov/news/news/financial/1999/fil9994.html, www.fdic.gov/bank/historical/history/contents.html, Freedom of Information Act (FOIA) Service Center, Relatively low borrowing costs and the easy availability of credit, Government policy, including income tax benefits, Long gestation periods that allowed supply-and-demand dynamics to change before a project’s completion, Nonrecourse lending and legal structures that shielded project sponsors from risk, Out-of-area lending, including the purchase of loan participations from out-of-area lenders, An unregulated real estate appraisal industry that often used inflated assumptions and relied on inexperienced appraisers, Total loans reported on the Report of Condition for construction, land development, and other land represent 100 percent or more of the institution’s total capital; or. 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