implementation of interagency guidance on concentrations in commercial real estate lending, sound...
TRANSCRIPT
Implementationof Interagency Guidance on
Concentrations in Commercial Real Estate Lending,
Sound Risk Management Practices
January 30, 2007Denise Dittrich [email protected] Reserve Board
2
Background
Proposed guidance issued in January 2006
Considerable feedback from the industry
Final guidance issued by the Federal Reserve, OCC and FDIC on December 12, 2006
OTS separately issued similar CRE guidance
3
Why are Supervisors Concerned about CRE Concentrations?
CRE lending is a significant business line for many small to medium-sized institutions
CRE has historically been highly cyclical which led to large losses in the banking industry
CRE concentration ratios are at record levels
Rising interest rates could affect debt service coverage ratios and property values
Risk management practices and strategic and capital planning have not always kept pace with growth in CRE lending
Source: Call Report
Trend in CRE Concentrations by Asset SizeAll Commercial & Savings Banks
(Total CRE Loans / Total Risk-based Capital)
0
50
100
150
200
250
300
350
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006Q3
Per
cent
Total Assets < $100 Mn
Total Assets $100 Mn - $1 Bn
Total Assets $1 - $10 Bn
Total Assets > $10 Bn
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What’s Different From the Past?
More disciplined underwriting Regulatory lending standards Appraisal profession better regulated Transactions not tax driven More liquid CRE markets Better market data
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What’s Happening Now?
Frothy CRE markets – cap rates, prices, debt service coverage
Slowing housing markets – residential construction
New sources of market liquidity – CMBS, hedge funds
Plus, lender surveys reveal:
Declining underwriting standards Hyper competition Expectations for declining asset quality
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A Tour of The Guidance
Directed to institutions with significant CRE lending
Applies to banks but principles are broadly applicable to bank holding companies and their non-bank subsidiaries
Outlines key risk management expectations
Reinforces and builds upon existing regulations and supervisory guidelines
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Focus of the Guidance
Focus is on concentrations in types of CRE loans that expose institutions to cyclical conditions in real estate markets, includes:
“Non-owner occupied loans” where repayment is dependent on the rental income or sale or refinancing of the real estate held as collateral
Residential and commercial construction and development loans
Excludes “owner-occupied” RE loans where repayment is from cash flow from operations
Consistent with Call Report changes
Excludes real estate taken as a secondary source of repayment or in an abundance of caution
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Guidance establishes numerical criteria for identifying institutions with potentially significant CRE concentration risk
Using Call Report data, supervisors will focus on institutions with:
(1) Construction & land development loans ≥ 100% of capital; or
(2) Total CRE loans ≥ 300% of capital and ≥ 50% growth in CRE portfolio over last 36 months
Supervisory Monitoring Criteria
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Purpose of Supervisory Criteria
Used to identify institutions with potential concentration risk
Criteria should not be viewed as limits on lending activity
There is no “safe harbor” if other risk indicators are present, such as:
Rapid growth in CRE lending Significant growth in CRE credit concentrations Concentrations in certain property types
Criteria is only to be used as a starting point for conducting further analysis
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Purpose of Supervisory Criteria (cont.)
Institutions meeting criteria would be expected to be able to demonstrate the risk characteristics of their CRE portfolio by property type, market, and borrower
Institutions are expected to perform their own assessment of CRE concentration risk
Examiners will avoid an extended discussion on segmentation of individual loans, focus should be on the portfolio management
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Implementation of Guidance
Effective as of December 12, 2006
This is not a “one size fits all” process
Examiners will use a risk-based approach and exercise examiner discretion
Examiners will be flexible with institutions on the timeframe for meeting risk management expectations
Agencies will provide training to examiners on proper implementation of the guidance
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Expectations for Risk Management
Guidance applies to institutions of all sizes
Sophistication of risk management systems will vary with CRE portfolio’s risk characteristics, size and complexity
Evaluation of risk management systems will consider varying risk profiles of loans secured by different property types
Relatively simple systems may work for some banks
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Expectations for Risk Management
Board and management oversight
Management information systems
Market analysis
Portfolio stress testing and sensitivity analysis
Credit underwriting standards
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Board and Management Oversight
The Board has ultimate responsibility for risk assumed Approve overall CRE strategy and risk tolerance
levels Monitor how the strategy is progressing and if its
policies are being complied with Approve contingency plan
Management is responsible for implementing the CRE strategy on a day-to-day basis in compliance with board approved policies
Design operating policies and procedures that enable it to identify, manage, monitor, and control CRE risks
Provide the board with reports showing strategic targets including portfolio risk levels
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Management Information Systems
Identify key data elements relevant to portfolio
Produce reports relevant to board and management oversight of strategy and policy implementation
Provide useful stratifications including loan type, property type, geographic location, risk grade, delinquency status
Provide for systematic review and evaluation of portfolio risk levels and changes
Facilitate portfolio level stress testing of alternative scenarios
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Market Analysis
Provide management with sufficient information on current market conditions and factors that could influence those conditions in the future
Incorporate data and anecdotal information to develop a reasoned view of market conditions and prospects
Should utilize multiple sources of information for a balanced view
Should be integrated into the strategic plan development and risk management
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Market Analysis (cont.)
Types and sources will vary depending on composition of portfolio and markets served
Frequency of updates depends on size, scope and complexity of portfolio and stability of market conditions
Analysis may contribute variables for stress testing
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Portfolio Stress Testing and Sensitivity Analysis
Analysis will assist management and the board in understanding how changes in relevant economic or market factors could affect the portfolio or key portfolio segments
Sophistication of process will vary with complexity of the portfolio
Analysis should measure the effect on earnings and capital and portfolio quality
Results should be considered in strategic planning and risk management
Results should be updated periodically and shared in writing with senior management and the board
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Underwriting Standards
Lending policies should reflect the level of risk that is acceptable to the board
Underwriting criteria should be clear and measurable Maximum loan amount by type of property Loan terms Pricing LTV limits Collateral valuation Debt service coverage
Tight control over policy exceptions
Review and amend standards, as needed, based on results of market analysis
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Evaluation of Capital Adequacy
Guidance does not imply that banks will necessarily need to increase capital just because they have a concentration
Institutions should consider the level of capital support for CRE concentrations in their strategic, financial and capital planning
Supervisors will take into account inherent risk and quality of risk management practices
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Points of Emphasis
Supervisory criteria are not limits, rather they are to be used as supervisory monitoring tools
Banks should perform internal risk assessments Board and management oversight is critical Expectations for risk management practices will be
commensurate with risk profile of institution Capital adequacy will be evaluated on a case-by-
case basis Guidance does not supercede the Agencies’ real
estate lending and appraisal standards