Community banks, by their very nature, tend to have higher concentrations of commercial real estate (CRE) loans than larger institutions. Any concentration in certain types of loans, borrowers or collateral exposes banks to heightened risks, so your bank needs to be proactive in managing CRE concentration risk. This is particularly critical today, because a confluence of recent trends has elevated CRE risks for many banks.
The following three key trends are affecting community banks’ CRE risks and will likely continue to do so in the foreseeable future:
In light of these trends, it’s more important than ever for banks to shore up their risk management programs for CRE concentrations, particularly in the office sector.
Risk management strategies
In assessing a bank’s risk management program, it’s helpful to consult the federal banking agencies’ 2015 joint Statement on Prudent Risk Management for Commercial Real Estate Lending. Among other things, the statement urges banks with high CRE concentrations to:
Valuable guidance can also be found in the agencies’ Supervision and Regulation (SR) Letter 07-1, Interagency Guidance on Concentrations in Commercial Real Estate. That guidance outlines the key elements of a robust risk management framework, including: 1) a strong management information system to identify, measure, monitor and manage CRE concentration risk; 2) market analysis, which allows banks to determine whether their CRE lending strategy and policies continue to be appropriate based on changes in market conditions; and 3) clear and measurable credit underwriting standards that facilitate evaluation of all relevant credit factors. Other elements discussed in the letter include board and management oversight, portfolio management, portfolio stress testing, sensitivity analysis, and the credit risk review function.
CRE lending has become riskier in recent years. You can manage this risk, however, if your bank monitors its CRE portfolio, keeps abreast of changing market conditions, and implements sound risk management practices.
Contact us with questions.