Ardmore Banking Advisors June Newsletter: Prudent Management of Your Bank's Commercial Real Estate Exposure


by Suzanne Storm - Senior Consultant for Credit Policy & Risk Managment

The OCC, Federal Reserve and the FDIC issued an Interagency Statement in December 2015 to remind all banks, regardless of size, the importance of prudent risk management of their commercial real estate (“CRE”) exposure throughout the economic cycle. The guidance was prompted by the agencies’ observation of substantial growth and increased competitive pressures in CRE lending, together with rising concentrations and loosening underwriting standards. Historical evidence demonstrates that financial institutions with high CRE credit concentrations and weak risk management practices are exposed to a greater risk of loss and failure.

Given the regulators’ observation of higher concentration levels, the agencies will be very focused on evaluating risk management of the CRE portfolio during their examinations. The expectation is that financial institutions maintain underwriting discipline and exercise prudent risk management practices that identify, measure, monitor, and manage the risks arising from their CRE lending activity on a continuing basis. The Interagency Statement specifies actions taken by financial institutions that succeeded during previous economic downturns, presumably delineating practices they expect to see in place to demonstrate good risk management. These include:

  • Adequate and appropriate loan policies (including concentration limits), underwriting standards, and lending strategies;
  • Capital adequacy and ALLL supporting the lending strategy and the level of inherent risk in the CRE portfolio;
  • Global cash flow analysis based on reasonable assumptions to ensure repayment capacity;
  • Market and scenario analysis (i.e., stress testing) of the CRE loan portfolio;
  • Providing board and management sufficient information to assess whether the lending strategy and policies continue to be appropriate in light of changes in market conditions;
  • Assessing the ongoing ability of the borrower and project to service all debt (i.e., performing at least annual reviews), with attention to conversion from interest-only to amortizing payments and to increasing interest rates;
  • Procedures to monitor the potential volatility in supply and demand for various CRE product types (lots, retail, office, multi-family units, etc.);
  • MIS that provides the board and management with sufficient information to identify, measure, monitor, and manage concentration risk; and
  • Appraisal reviews to ensure sufficient information is contained in the appraisal to support an appropriate market value conclusion based on reasonable market rents, absorption periods, and expenses.

Throughout 2016, examiners will focus on appropriate implementation of the prudent principles in the Concentration Guidance, especially for those institutions that have recently experienced substantial growth in CRE lending activity or whose lending strategy calls for such growth. If risk management of the CRE lending activity is not found adequate, a bank may be required to:

  • Develop a written plan to identify, measure, monitor and manage CRE concentrations;
  • Reduce risk tolerances in their underwriting standards; or
  • Raise additional capital to mitigate the risk associated with their CRE strategies or exposures.

If Ardmore can be of any assistance to you in preparing to meet these regulator expectations, or in reviewing your readiness, please contact Lou Dunham at 847-687-7353 or