Commercial Real Estate Concentrations – A Regulatory View

Posted on February 16, 2017 at 9:00 AM by Josh Thompson

The Office of the Comptroller of the Currency (OCC) also continues to voice its concerns about credit concentration in Commercial Real Estate (CRE—construction, non-residential mortgage, and multifamily housing). The OCC’s latest “Risk Perspective” publication layered in the OCC’s mixed CRE performance outlook – indicative of slowing property value growth, impending increase(s) in the cost of capital, and possible upticks in industry vacancy rates (particularly among the Apartment segment).

Given fierce competitive pressures experienced by banks at the local, regional, and national levels, the abundance of market liquidity, and an unprecedented low interest rate environment, it’s no surprise that smaller financial institutions have embraced the growth opportunities available in the real estate markets.

Banks are in the business of taking risk; however, as an industry we simply cannot ignore that some segments are inherently more volatile than others. On the same token, I’m not by any means suggesting that lenders should abstain or unnecessarily restrict lending in the segment altogether. Despite current and potential legislation aimed at easing some regulatory-driven pressure, banks of all sizes should continue to expect and prepare for added scrutiny in CRE underwriting standards.  

At this point, you may be wondering if real estate concentrations were such a large industry concern why the “Bank Reg Data Q4 2016 Non-Performing Loans” (NPL) report reflected a continuation of the declining NPL percentages in CRE assets. Notably, Multi-family NPLs are at a mere 0.18%, the lowest we’ve seen in nine consecutive quarters. The one caveat, however, is that numbers, especially percentages, often don’t tell the whole story. NPL percentages are derived by dividing the aggregate NPLs (numerator) by the total portfolio loan amounts of all CRE portfolios (denominator). Given rapid CRE growth (for example, over the last 3 years, Multifamily is up $111 billion and Construction is up $93 billion), and thus a significant increase to the gross portfolio – “the denominator” – portfolio performance metrics such as NPLs and Delinquencies, can appear punitive when analyzed at face value. 

So, where do FIs go from here, and what should they consider doing to either maintain asset diversification or help mitigate real estate credit concentration they currently have in their portfolio? Please check back soon for a follow-up post covering some best practices to help mitigate concentration risk (particularly with real estate).

Click here to read Part 1 of this blog series. 

 

Topics: commercial real estate, commercial lending, regulatory

Josh Thompson

Written by Josh Thompson

As Business Process Architect for Baker Hill, Josh Thompson assists with product sales, implements software and provides industry guidance to new and existing Baker Hill clients. Thompson is responsible for creating new client opportunities and furthering current clients’ success. He equips Baker Hill clients with both strategic and tactical industry recommendations, as well as supplies configuration assistance during software implementation. Thompson received his bachelor’s degree in Finance and Real Estate from Indiana University, Bloomington. He is in the process of earning his master’s degree in Business Administration, Finance and Leadership from Butler University, Indianapolis.

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