Commercial Magazine

Regulators Eye Commercial Loans

Greater scrutiny of loan and credit issues will require brokers to work closely with lenders

By Stephen Curry

Last December, one federal agency began showing increased concern about commercial real estate loans. The Federal Deposit Insurance Corporation (FDIC), an independent agency created by Congress to maintain stability and public confidence in the nation’s financial system, wasn’t sounding very confident about the concentration of commercial loans at some lenders.

The agency issued a financial institution letter that warned banks and other lenders that have high concentrations of commercial real estate loans. The guidance offered criteria for how banks would trigger heightened regulatory monitoring.

“Commercial brokers need to be aware of the risk-management analysis federal regulators recommend so they can advise their clients on the best strategies for working with lenders.”

The criteria included the 100/300 rule. This rule states that if a lender’s loans for construction, land development and other land represents 100% or more of the institution’s tier 1 capital, plus allowance for credit losses (ACL), it may be subject to more rigorous scrutiny. The same rule holds for lenders where the commercial real estate loan concentrations exceed 300% of their tier 1 capital, plus ACL. Roughly one-third of U.S. lending institutions have individual concentration ratios that exceed the 300% benchmark, according to the Federal Reserve Bank of St. Louis.

The criteria also includes cases where the outstanding balance of the commercial loan portfolio has surged by 50% or more in the preceding 36 months. Given the aggressive approach shown by federal agencies so far, this is an early warning of even more examination of a bank’s risk, liquidity, credit administration, reserves and capital adequacy.

Commercial brokers need to be aware of the risk-management analysis federal regulators recommend so they can advise their clients on the best strategies for working with lenders. The risk-management regulations may also help brokers decide which lenders would be best to approach when seeking a loan.

Risk management

The FDIC guidance underscores the need for institutions to pay closer attention to key areas and ultimately strengthen their credit risk management practices. Some key areas for banks and other lenders include needing to establish stable, reliable funding sources with robust liquidity contingency plans. They also should be able to use the Federal Reserve Discount Window, a program that provides immediate access to funds, as a source of potential liquidity.

Maintaining appropriate levels of cash and cash equivalents alongside a stable and diverse range of funding mechanisms is critical. Lenders must ensure valuation policies and procedures capture changes in property values. They also must confirm that capital and ACL levels are adequate and that they have defined and prepared workout processes for deployment, in case the credit losses grow larger than expected.

Institutions with high commercial concentrations — especially in office lending — need to greatly increase capital reserves to provide ample protection against unexpected losses. Implementing management information systems delivering relevant data on concentration levels and related market conditions also can help institutions better protect themselves from any commercial real estate risks.

Best Practices

For any financial institution, risk is a constantly moving target. Every situation will be different. Keeping in mind a few best practices for risk management will help banks and other lenders better prepare themselves for the increased regulatory scrutiny that lies ahead.

Periodic, at least quarterly, analysis of the collectability of commercial loans — and all other exposures — will help financial institutions maintain better visibility on their current portfolio. Another area to focus on is an analysis to be sure that ACLs are being maintained at an appropriate level to cover expected credit losses on individually evaluated loans and the remainder of the loan portfolio.

Keeping a robust credit review and a risk rating system will help identify deteriorating credit trends early in the process. Ultimately, financial institutions must effectively manage their interest reserves, as well as terms and conditions. They also should have an accurate reflection of the borrower’s condition in loan ratings and documented reviews.

In keeping with generally accepted accounting principles, management should consider the effects of past events, current conditions, and reasonable and supportable forecasts when estimating expected credit losses. Relevant forward-looking information and expectations from reasonable and supportable forecasts are required for this estimate.

Next Steps

In light of this information from the FDIC, banks are reminded of the critical importance of maintaining recent financial statements from borrowers. These include property cash flow statements, rent rolls, guarantor personal statements, tax return data and other income property performance information.

Financial institutions are also being reminded to emphasize the global financial analysis of their pending loan maturities and lease expirations, and the concentration of individual property owners, builders and developers in a loan portfolio. Brokers and their clients need to be aware that this information can be requested by federal regulators and be ready to help lenders with this process in any way they can.

Lenders also must reevaluate the relevance of appraisals and evaluations performed during prior economic or market conditions and update collateral valuation information as necessary as market and individual property conditions change. Banks should ensure they are undertaking meaningful stress testing.

Finally, though not explicitly mentioned, strategic operating plans are crucial for informing regulators about a bank’s future plans for commercial lending, liquidity and capital. In case a loan goes into default, lenders need to clarify a workout capability. The biggest shortfall for most banks will be tracking borrower and guarantor financials, as well as property cash flow statements or rent rolls and forward-looking appraisals.

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Brokers need to understand what regulators are requiring from lenders involved in financing commercial real estate. And lenders must be sure they have the resources to collect what is needed by the regulators now and in the future as the environment continues to evolve. The financial institutions that want to succeed in commercial lending must take steps now to remove risk and stabilize their future in the industry.

A proactive approach is also required from brokers and their clients. They need to work with lenders to supply all the information required. That will ensure that borrowers are able to secure the loans needed and to successfully navigate this increasingly complex and regulated system. ●


  • Stephen Curry

    Stephen Curry is CEO of Endurance Advisory Partners, a bank risk management consulting firm. Curry has been providing advisory services to management teams and boards of national and regional banks, financial services companies, start-ups and private investor groups since leaving Bank of America in 2009. He has successfully guided these firms through acquisitions and divestitures, merger integrations, digital transformations, operational restructurings, implementation of growth strategies and resolved complex regulatory issues. In addition, Curry has served as chairman, CEO or president at banks ranging in size from $800 million to $30 billion.

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