A Regulator's Notebook: Keeping Track of Real Estate and Mortgage Lending Practices

Julie L. Stackhouse

Regulators frequently discuss emerging issues and ways to monitor trends. In the Eighth District, our current list of "radar risk" issues is short; however, a few continue from month-to-month, especially when we examine mortgage and commercial real estate lending practices.

During the last year or so, we've seen noteworthy changes in the home mortgage market. Currently, about one-third of all mortgage originations nationwide are adjustable rate mortgages, representing almost one-half of the dollar value of new mortgages. Some market analysts also report that interest-only mortgages now make up roughly 10 percent to 20 percent of the mortgage portfolios of some of the nation's largest banks.

Although adjustable-rate and interest-only mortgages are suitable for many borrowers, some borrowers have little cash flow flexibility—creating risk should interest rates change sharply. In other cases, the borrower's ability to repay the principal balance is dependent not on the borrower systematically paying down the principal, but rather the eventual sale of the home. So we become especially watchful when these types of loans appear to finance speculative purchases.

We also carefully monitor commercial real estate loans (CREs), which are growing in many community banks' loan portfolios. Community banks usually do a good job of underwriting CRE loans. Most banks compete effectively in this market because they know their market well and have the ability to tailor loan terms and closely monitor projects. Nonetheless, more CRE loans can mean concentration risk—putting too many eggs in one type of lending basket—thereby increasing the need for banks to maintain high underwriting standards and sound risk-management practices.

As a bank's CRE concentrations grow, our examiners will expect to see:

  • strong management information systems that can distinguish CREs by geographic location, property type, loan-to-value and phase of construction; and
  • effective procedures for monitoring primary real estate markets and assessing the quality of appraisals.

For more significant concentrations in larger organizations, we also may look for the bank's ability to stress-test individual loans and loan portfolios by type and location.

In summary, today's "regulator's notebook" for community banks is focused on the mortgage and CRE markets. We realize that rapid growth in these areas reflects opportunities for financial institutions, but we still encourage bankers to engage in prudent risk management.

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