National banks and federally chartered thrifts hold over $700 billion in total CRE loans, which amount to 14 percent of their aggregate loan portfolios. However, and as expected, CRE accounts for 37 percent of the total loan portfolios of institutions in the OCC’s Community Bank Supervision program. Mr. Curry stated that the OCC recognizes that “CRE is a bread-and-butter product for community banks and thrifts” and that a well-managed CRE portfolio is central to a community bank’s long-term health.
He noted that unfortunately in too many cases CRE concentrations have led to significant losses and failures of community banks. The vast majority of failures over the past three years involved CRE to some degree and in most cases the exposure was the primary reason for failure.
The primary culprit is construction and development loans. In March 2007, nearly 2,000 banks held C&D loans that exceeded their capital. By September 2011, 13 percent of them failed. If you analyze banks using the 100/300 percent threshold outlined in the 2006 Interagency CRE Guidance, 23 percent of banks that had concentrations in excess of those limits failed. For banks within those thresholds, the outcome was far more favorable and only about one-half of one percent failed.
I have heard those statistics previously but they are so significant that they warrant being repeated.
The Comptroller went on to discuss trends in the CRE market which indicate that:
- Demand for multifamily housing is increasing, largely due to the decline in homeownership rates from the economic downturn, and supply is growing as well;
- Demand for office buildings is growing steadily but at a moderate pace because of slow growth in employment; and
- Demand for retail and warehouse space is improving slightly due to increased consumption but weakness in other sectors as well as technology advances that favor internet sales over retail sales is still disrupting some market segments.
The supervisor stated that there are still significant obstacles to overcome including the fact that up to half of all outstanding CRE loans will mature by 2014 and many of these loans are currently on an interest-only or minimal amortization required basis. Bankers will have to resolve repayment issues, such as declining net operating income and underwater mortgages, while dealing with difficult economic conditions.
On an optimistic note, Mr. Curry stated that eventually the environment will improve and that learning from the mistakes of the financial crisis is where the agency will be focus moving forward.
More specifically, he mentioned that the OCC’s new handbook on credit concentrations. The handbook focuses on concentration risk management and encourages banks to recognize correlations between loan pool concentrations and emphasizes that different pools of the same size may represent different levels of risk.
The agency is also closely focusing on the appraisal process. The expectation is that banks will obtain appraisals from competent and qualified professional appraisers who will provide unbiased market value conclusions and that a documented review process is in place.
The OCC has also directed banks with significant CRE concentrations to develop more rigorous scenario analysis, or stress testing, that considers the effect of multiple variables, including interest rate changes, vacancy rates, and capitalization rates.
If you have been reading this article carefully, the Comptroller clearly outlined the CRE fundamentals that should be the driving factors in your stress testing analysis (vacancy rates, rental rates, and ultimately the NOI). If your institution has been one of the institutions he mentioned that has rolled over CRE loans on a short-term basis and is now faced with looming maturities, your stress test analysis should also include increased interest rates (as the upcoming maturities may have carried below market rates) and payment terms (if the upcoming maturities were largely interest-only payments).
The full text of his speech can be found at: http://www.occ.gov/news-issuances/news-releases/2012/nr-occ-2012-89.html