CRE Concentrations Increase
Regulators have started to focus their attention on the spike in commercial real estate lending by banks as the economy continues to improve. Given we are almost a decade out from the “Great Recession” of 2008, it is not surprising that banking regulators have started to take a more aggressive stance on the magic 300% CRE concentration level as a percentage of capital. We have been in a relatively pristine credit quality cycle over the last several years with NPAs almost universally well below 1%, loan loss reserves still relatively strong, though declining as a percentage of loans outstanding and provisions which primarily mirror loan growth.
What Does This Mean For Your Bank?
If you are flirting with or exceeding the magic 300% CRE concentration barrier, then be prepared for tighter offsite and onsite exam scrutiny. We have seen the regulators bundle owner-occupied CRE with non-owner-occupied CRE in applying the 300% concentration threshold. This is because they say their experience is that owner-occupied CRE has fared just as poorly as non-owner-occupied CRE in many markets. A word to the wise: if you want to exceed the concentration threshold, make sure you have pristine policies and procedures and tracking mechanisms. We have seen management rating downgrades without significant losses or performance issues, even when asset quality still remains a “2.” I would strongly suggest taking a proactive approach with your regulators if you go the concentration route. It will surface sooner or later, so vetting the issue upfront is the smart way to go.
What About M&A?
I think it goes without saying that the individual bank CRE concentration levels and combined post-merger level will be closely scrutinized. As a recent example, the New York Community Bancorp/Astoria Financial $2 billion deal was terminated under speculation that one issue may have been commercial real estate concentrations, which has been a regulatory hot button. Shareholders of both companies approved the transaction last April, lending some credence to the speculation of a regulatory issue. The regulators clearly are wary of a repeat of what happened almost a decade ago and are loathe to “have their fingerprints” on a deal they approved go south because of high CRE concentrations. Obviously, in today’s environment you need to discuss any M&A with your regulators before going too far down the tracks, and especially if there are CRE concentration issues.
Concentrations in General
While the reality is that most community banks do a significant amount of lending in the CRE arena, if there is one take away from the recession, it is that significant concentrations in any area, particularly higher-risk construction lending, are potentially dangerous. While there is continuing pressure to increase Net Income, constrained by narrow interest rate margins, the regulators do not want to experience déjà vu. Thus, I would encourage you to carefully consider this area and ensure your board is fully aware of your approach, regulatory concerns, and the attendant risks of undue concentrations.