In this Quarterly release Joseph Hill shares his thoughts on relationship lending, community bank CRE growth, and the competitive edge of truly understanding a Borrower’s business. We then would like to introduce Mr. Dean Morgan as CEIS’ Regional Executive for Tennessee and the nearby Southern States, and lastly, leave with an excellent article on tackling Risk Management of a Commercial Real Estate Concentration.
2. ON MY MIND – CEIS PRESIDENT, JOE
HILL
With the current healthy lending environment
Banks are actively booking CRE
At some organizations they are increasing C&I
transactions to grow their portfolios
Competition for quality borrowers is stiff
The community banking community is not only
competing against each other but also against the
larger banks or nonbanking organizations
These professional capabilities, below, have long
since been the differentiator and competitive
edge in dealing with competition
Relationship lending
Knowing the business of the borrower
Personal attention provided to borrowers
Causes of the competitive market
Easing of credit quality requirements
Concessions in pricing, structure and overall terms
Loan and credit trends as well transactional
levels should be tracked so the need for
reconsideration in policies and practices can be
identified
3. INDUSTRY EVENTS
Recent releases which pertain to our clients
New Off-Site Loan Review Options with the Federal Reserve fir
Community Banks with les than $50 Billion in Total Assets
New MBL Rule Could Open up More Niche Lending
House Passes ICBA – Advocated Bill Improving Community Banks
Access to Capital
Guidance for Banks’ Maintenance of Records, Record Retention &
Examiner Access
4. IN THE SPOTLIGHT – DEAN MORGAN
Regional Executive
Business Development
Engagement Management throughout the Southern Region
of the US
Banking History/Past Titles
25 years of senior and executive level banking
Senior Loan Officer SVP- Corporate Banking and President &
CEO
5. COMMERCIAL REAL ESTATE:
CONCENTRATION RISK MANAGEMENT
The risks posed by concentrations of credit risk in general, and
Commercial Real Estate concentrations in particular, have long
been an area of focus for bank regulators.
FFIEC expectations for a risk management to manage the risk
associated with Commercial Real Estate (CRE) concentrations:
2006 Interagency Guidance: Concentrations in Commercial Real
Estate Lending, Sound Risk Management Practices
Statement on Prudent Risk Management for Commercial Real Estate
Lending
The remainder of this presentation will provide a high level
summary of the 2006 regulatory guidelines and to review current
areas of examination focus.
6. THE 2006 INTERAGENCY GUIDANCE
The 2006 Guidance notes that the CRE sector is vulnerable to
business cycle
Banks need to have appropriate risk management practices in place
and adequate capital to manage through these cycles
Key elements of risk management include:
Identification of concentrations
Board/management oversight
Active portfolio management
Management information systems
Market analysis
Underwriting standards
Stress testing/sensitivity analysis
Credit risk review
In summary, the Guidance noted that “regardless of its size, an
institution should be able to identify and monitor CRE
concentrations and the potential effect that changes in market
conditions may have on the institution.”
7. IDENTIFICATION OF CONCENTRATIONS
Regulators have established two thresholds that will assist them in
determining the level of a bank’s CRE concentration risk
Construction, land development & other land = 100% of risk-based capital
Commercial Real Estate = 300% of risk based capital and the concentration
has increased by 50% or more in the last 3 years
This category includes properties where 50% or more of cash flow is from
third parties or where bank depends on sale of the property or permanent
financing for repayment
The thresholds are intended to be benchmarks, above which the
regulators would expect to see components of the risk management
framework outlined in the Guidance
Banks are not exempt from supervision just because they are under these
benchmarks
Different types of real estate carry different risks. Banks need segment
portfolios by stratifying the portfolio by risk characteristics and by
sensitivity to economic, financial or business developments in order to be
able to measure and manage risk
8. BOARD AND MANAGEMENT OVERSIGHT +
MANAGEMENT INFORMATION SYSTEMS
Management and the Board should involved in the process
Establish policy guidelines and lending strategy for CRE lending
Require management to implement procedures and controls that
will ensure adherence to the Banks overall policies
Use this information determine whether the Bank’s strategies and
policies (including limits and sub-limits) remain appropriate in light of
current market conditions.
Banks will need adequate management information systems to
monitor CRE risk
The MIS must report necessary information
The MIS must be reviewed from time to time to make sure it
remains adequate
The MIS must provide the means of reviewing both current data and
the extent to which measurements have changed over time,
including risk rating migration.
9. MARKET ANALYSIS
The regulators note that “the important objective is that an
institution should have the information necessary to assess
the potential effect of market changes on its CRE portfolio
and lending strategy.”
Banks should be able “demonstrate that it has an understanding
of the economic and business factors influencing its lending
markets”
Market risks the 2006 Guidance focuses on specifically:
Demand
Changes in cap rates
Vacancy Rates
Rents
Banks need to be able to identify these risks within their loan
portfolios and continually adjust accordingly
10. CREDIT UNDERWRITING
Clear underwriting policies are necessary if a Bank wants to
appropriately manage the risk in their portfolios
Internal factors underwriting policies should address:
Historical experience
Staff Capabilities
Technological Resources
External factors underwriting policies should address:
Market position
The bank’s existing/future trade area
Trends in lending and funding
Analysis should address the overall financial condition of the
borrower as well as focusing on the specific project.
RE construction loans,
Controls should be in place to make sure equity is contributed and
maintained
A process that documents construction progress, track pre-sale/pre-
leasing and exception monitoring and reporting should be implemented
11. CREDIT UNDERWRITING CONT.
Policies should establish maximum exposure by
Type of property and appropriate loan terms
Pricing and LTV
Requirements for feasibility studies and/or sensitivity/stress testing
Minimum hard equity contribution from the borrower
Minimum borrower net worth
Cash flow and debt service coverage
Collateral valuation
Policies need exception-handling procedures
Exceptions should be infrequent
When an exception is necessary, they should be reported to the Board
and Senior management
This report should include trends in the frequency of exceptions
and how many underwritings have these exceptions in place
12. STRESS TESTING/SENSITIVITY ANALYSIS
+ PORTFOLIO MANAGEMENT
Banks with CRE levels in excess of the regulatory thresholds
are expected to analyze the impact of changes in market
conditions or interest rates on the portfolio
It should focus on the overall effects of changing market
conditions and their impact on asset quality, capital and
earnings
Analysis of capital levels in stressed scenarios can provide
significant support for justifying CRE concentration, or for
supporting increases in such a concentration.
Regulators look for these characteristics in the testing
strategies:
Adjustments in credit risk ratings
Contingency plans to limit or reduce exposure
The use of derivatives
13. EXPLAINING THE DECEMBER 2015
STATEMENT
This statement draws attention to:
Growth in CRE portfolios
Declining CAP rates
Rising property values
The lack of negative signals from vacancy and
absorption rates and levels of non-performing loans
and charge offs
Banks who complied with these regulations, were able to succeed during
the downturn in 2007-2010:
Adequate policies, underwriting standards, credit risk management
standards, and concentration limits set at board level, lending strategies
and monitoring of same, and strategies to ensure capital/ALLL adequacy
appropriate to portfolio risk
Preparation of borrower’s global cash flow analysis based on reasonable
rents, sales projections and expenses
Performance of periodic market and scenario analyses of CRE portfolio
Provision of appropriate periodic information to the Board for the latter
to assess ongoing appropriateness of strategy and policies
Assessment of ability of borrower to P&I/m when IO converts to
payout/absorb impact of rising interest rates
Implementation of procedures for monitoring potential volatility in
supply/demand for/of lot, retail/office space and MF units
Implementation of systems which give management and the board
sufficient information to identify, measure, monitor and manage
concentration risk.
Appraisal review process to ensuring adequate information to support
market value conclusion
14. CURRENT AREAS OF SUPERVISORY
FOCUS
Regulators look to focus on banks with CRE portfolios that have grown
quickly, banks with CRE portfolios that include high risk segments,
and/or banks whose CRE portfolios are approaching or have passed the
regulatory thresholds.
When assessing risk, regulators will focus on:
Diversification
Geographic dispersion
Underwriting standards
Guarantees
Level of pre-sale/pre-lease or other identified take out
Portfolio liquidity
Current market conditions
The quality of recent new/ renewed underwriting
Senior management’s and the Board’s efforts to monitor trends
15. CONCLUSION
Banks with significant growth in CRE and which either
currently exceed the regulatory benchmarks for a CRE
concentration, or which are likely to exceed these
levels in the near future, are encouraged to review
their policies and processes to ensure that their risk
management framework includes the components
outlined in the 2006 and 2016 regulatory publications.
Contact CEIS to discuss your options
Phone #: 888-967-7380