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Federal Agencies Issue Guidance on Commercial Real Estate Concentrations

Sunday, April 1, 2007

Commercial real estate can be a profitable component of a financial institution. Federal regulatory institutions want to help make sure that institutions that pursue a significant commercial real estate lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities.

With such concerns in mind, federal banking agencies in December issued guidance on risk management expectations for banks with significant concentrations in commercial real estate (CRE) loans. Some bankers have expressed concerns that any benchmarks contained in the guidance would become hard limits, while others indicated a concern that the risk management requirements were unnecessarily burdensome.

The guidance was considered necessary because many banks, particularly community banks, have become increasingly dependent on CRE lending. The agencies are concerned that without strong underwriting and risk management practices, banks with high CRE concentrations may be exposed to earnings and capital volatility in the event there are adverse changes in CRE markets.

The final guidelines also make it clear that the bank regulatory agencies will make every effort to apply the guidelines reasonably and consistently. To help achieve those goals, examiner training will be provided on an inter-agency basis.

"As part of our regular contact with our state member banks, we will make sure they are familiar with the guidance," says Tim Bosch, division vice president in Banking Supervision & Regulation at the St. Louis Fed. "We will provide our banks a reasonable transition period to enhance their risk management practices and management information systems where necessary."

The guidance does not limit banks' commercial real estate lending, but rather guides institutions in developing risk management practices that are consistent with the level and nature of their CRE portfolio. The loans covered are those dependent upon the cash flow derived from the real estate held as collateral and are sensitive to conditions in local or regional commercial real estate markets. Loans secured by owner-occupied properties or when CRE collateral is taken as an abundance of caution are generally excluded.

The numerical concentration screening, which now includes a loan growth measure, will be used as a supervisory monitoring tool, not a limit. For monitoring purposes, a CRE concentration is defined as:

  • Total loans for construction, land development, and other land loans equal to 100 percent or more of total capital; or
  • Total CRE loans equal to 300 percent of total capital (excluding owner-occupied CRE) and CRE loans increased by 50 percent or more within the past 36 months.

Over time, banks with high CRE concentrations will be expected to set policy limits consistent with the strength of their operating practices, credit underwriting and capital. Bankers should understand the risks in the CRE portfolio, not just the quality of the individual credits. They should know the bank's lending markets and understand the impact should a real estate shock occur. Banks will be expected to have management information systems (commensurate with the size and complexity of the bank) that enable them to measure, monitor and prudently control the risks inherent in the CRE portfolio.

"Superficially, about 40 percent of Eighth District state member banks have CRE concentrations that exceed one or both of the monitoring screen ratios," Bosch says.

For more information, see