CRE Loan Concentrations in 2017: What You Need To Know

Transcription

1 CRE Loan Concentrations in 2017: What You Need To Know NEW JERSEY BANKERS ASSOCIATION 113 th Annual Conference The Breakers, Palm Beach, FL May 17-21, 2017 Michael T. Rave Partner Day Pitney LLP (973) Adam Mustafa Managing Partner Invictus Consulting Group LLC (212)

2 Overview of Concentration Issues Pools of individual transactions that may perform similarly because of a common characteristic or common sensitivity are primary cause of credit distress Past problematic loan concentrations include: CRE Energy Loans CDOs Counter Party Credit Agricultural Loans Page 2 May 18, 2017 CRE Loan Concentrations

3 Other Loan Pools That May Be Viewed As Concentrations Include Loans: Dependent on same source of repayment Extended to industry or economic segment Purchased from single source Originated within a geographic area Page 3 May 18, 2017 CRE Loan Concentrations

4 What Is A Concentration? Direct, indirect or contingent obligations exceeding 25% of the bank s capital Bank s capital not defined but practice is to use Tier I Risk-Based Capital ALLL May be appropriate to combine pools with less than 25% of bank s capital if there is a common characteristic or common sensitivity to economic, financial or business developments. Page 4 May 18, 2017 CRE Loan Concentrations

5 CRE Concentrations 2006 Intra-agency guidance sets forth standards for CRE concentrations which are still followed by the agencies today Page 5 May 18, 2017 CRE Loan Concentrations

6 2 Thresholds to Identify CRE Loan Concentrations 1. Loans for construction land development and other land 100% of total capital 2. Loans for construction, land development and other land and loans secured by non-farm, non-residential property and multi-family loans 300% of total capital AND CRE portfolio increased by 50% or more in past 36 months Page 6 May 18, 2017 CRE Loan Concentrations

7 These amounts are a screen only, there are no limits on CRE concentrations There is no safe harbor if other indicators are present, there may still be concentration risk Banks with recent significant CRE growth will receive closer review Page 7 May 18, 2017 CRE Loan Concentrations

8 CRE Concentrations CRE Lending Viewed As More Risky 2011 Study of 2008 Economic Downturn Banks with high CRE concentrations more susceptible to failure 23% of banks that exceeded both ratios failed compared to 0.5% of banks that exceeded neither 13% that exceeded construction ratio failed Page 8 May 18, 2017 CRE Loan Concentrations

9 FDIC Study of 80s and 90s Bank Failures High number of bank failures due to over investment in CRE loans Primary factors in failures were weak underwriting and portfolio management Other factors included: Lack of market information High leveraged transactions Low borrowing costs and easy credit Government policy Non-recourse lending Out-of-area lending Faulty appraisals Page 9 May 18, 2017 CRE Loan Concentrations

10 Types of Loans Covered Regulators focus on CRE loans that have risk profiles sensitive to market conditions and where cash flow is primary source of repayment Includes: Land development and construction (including 1-4 family residential and commercial) Other land loans Loans secured by multi-family and non-farm, non-residential property where 50% or more of repayment source is rental income Loans to REITs and unsecured loans to developers if performance linked to CRE market Loans where primary source of repayment are other operations and activities are not covered Page 10 May 18, 2017 CRE Loan Concentrations

11 Risk Management Banks with CRE concentration should have risk management program that contains following elements: Board and management oversight Portfolio management Management Information Systems Market analysis Credit underwriting standards Portfolio stress testing Credit risk review function Page 11 May 18, 2017 CRE Loan Concentrations

12 Supervisory Oversight Effectiveness of risk management practices is key component of oversight Significant growth in CRE will result in closer review Regulators will focus on: Portfolio diversification Geographic dispersion Underwriting standards Level of pre-sold units and other take-out commitments on construction loans Liquidity Regulators will closely examine capital adequacy Page 12 May 18, 2017 CRE Loan Concentrations

13 Agencies 2015 Statement on Risk Management of CRE Lending CRE concentration levels rising Agencies noted easing of underwriting standards Institutions with weak risk management and high CRE concentrations are at a higher risk of failure Page 13 May 18, 2017 CRE Loan Concentrations

14 Establish adequate: Recommended Actions Loan policies, underwriting standards and credit risk management policies Lending strategies Strategies to ensure capital adequacy Conduct cash flow analysis based on reasonable rental rates, sales projections and operating expenses Perform market and scenario analysis of CRE portfolio Provide board with information to assess lending strategy and policies Assess ongoing ability of borrower to service debt Implement procedures to monitor volatility Maintain adequate management information systems Implement processes for reviewing appraisal reports Page 14 May 18, 2017 CRE Loan Concentrations

15 Bank CRE Lending Increasing At end of first quarter 2016: 400 banks exceeded one concentration ratio 30 banks exceeded both ratios CRE loans made up 47% of total lending of the banks above concentration ratios, but 8% for banks below ratios 5.8% of banks with high concentrations were unprofitable compared to 4.9% for banks under the ratios Page 15 May 18, 2017 CRE Loan Concentrations