9 “hot spot” issues examiners see at banks with CRE loans
Commercial real estate lending continues to receive regulatory scrutiny and reminders for financial institutions to practice solid risk management. FDIC officials in March outlined several types of weaknesses in loan underwriting, administration and oversight practices that are emerging at some banks with CRE portfolios.
In its latest “Supervisory Insights” publication, the FDIC reiterated the importance of sound credit risk management practices in light of rapid growth in CRE portfolios at some institutions and in light of some institutions operating with a generally higher risk profile.
Banks exceeding supervisory criteria for concentrations for total CRE loans or total loans for land acquisition, development and construction currently reflect higher pre-tax return on assets than other institutions, according to the FDIC. However, in general, they are operating with a higher-risk profile based on a couple of measures, including leverage capital ratios, total risk-based capital ratios and whole-funding-to-assets ratios.
“As evidenced by the lessons learned from the recent crisis, loan portfolios warrant close monitoring during a growth cycle,” Doreen R. Eberley, director of the FDIC’s Division of Risk Management Supervision wrote in the publication. “Underwriting standards, credit administration practices, funding sources, and external market factors should be evaluated as part of ongoing oversight of loan portfolios, particularly when portfolios are growing rapidly or are large in relation to capital levels.”
“The time to focus on strengthening risk-management practices is now, as portfolios and concentrations are building, but before financial metrics are adversely affected,” the FDIC said.
Staff with the Division of Risk Management Supervision also stressed risk management during a March 28 meeting of the agency’s Advisory Committee on Community Banking.
Division Associate Director Rae-Ann Miller told committee members that the FDIC’s examination of lending trends in CRE (or other areas that have shown rapid growth, such as agricultural lending, oil & gas) should not be viewed as the agency having a negative view of the categories or as evidence that it is not reviewing other lending categories. However, she noted that growth in loan portfolios “can mask building risk” because it drives down the ratios of past-due loans and charge-offs. In addition, she noted, the current methodology for estimating credit losses can make the allowance for loan and lease losses (ALLL) look low.
Examiners have reported spotting some specific issues related to CRE portfolio loan underwriting, administration, and oversight practices during recent examinations, according to the FDIC. These include but are not limited to the following:
• The absence of, or unsupported or excessive, board-approved limits for CRE portfolios or portfolio segments;
• Inadequate reporting of concentrations to the institution’s board or relevant committee and lack of documented discussions regarding concentrations in board or relevant committee meetings;
• Weaknesses in underwriting practices, including numerous exceptions to the institution’s loan policy, inadequate tracking of loan-policy exceptions, unsupported cash flow projections, lack of global cash flow analysis of guarantors and excessive or inappropriate use of cash-out financing and interest-only payment terms;
• Use of inadequate or poorly supported risk factors within stress testing or sensitivity analysis of the CRE portfolio;
• Insufficient internal loan review coverage of CRE activities or improper risk ratings;
• Appraisal review programs that lacked adequate independence or expertise of reviewers;
• Inadequate stratification of CRE portfolios within the ALLL analysis;
• Ineffective construction loan oversight, including lack of timely inspections or adequate disbursement controls; and
• Strategic CRE planning deficiencies, including outdated or inadequate market analysis and lack of contingency plans that would identify options if CRE risks were to become problematic for the institution.
FDIC officials said risk management programs for concentrated loan portfolios require increased oversight, stronger practices related to credit management and liquidity management and enhanced information and reporting. They also call for more robust loan review and ALLL policies and practices and “possibly, higher capital levels.”