FDIC promises more scrutiny of commercial real estate loans from banks

The Federal Deposit Insurance Corp. plans to increase its review of banks’ exposure to commercial real estate lending, citing uncertainty about the future of labor and trade in the wake of the COVID-19 pandemic.

The agency said its reviewers will pay particular attention to testing new loans, as well as loans in sub-sectors and geographies that are experiencing stress, and those that are vulnerable because borrowers are paying high rates. higher interest.

In explaining the sharper focus, the FDIC pointed to rising interest rates, the effects of inflation and supply chain issues, and pandemic-related changes in real estate utilization. commercial.

The agency said late payment rates on commercial real estate loans are currently at historic lows, but said the strong performance was partly attributable to stimulus programs and borrowing costs that were low until recently.

“Additionally, banks have worked extensively with distressed borrowers during the pandemic, which likely suppressed delinquencies and may have ultimately limited losses by giving borrowers time and flexibility to resolve issues,” wrote FDIC officials in the latest edition of the agency’s regular newsletter. .

“Although some of the economic effects of the pandemic appear to be abating, some of its impacts may be long-lasting or may have exacerbated existing secular trends, or both.”

According to Trepp’s TALLR database, delinquency rates on bank loans for office space have steadily increased from 0.2% in the fourth quarter of 2019 to 1.8% in the first quarter of this year.

Adobe Stock

The agency has drawn particular attention to segments of the CRE market that have been hit hard by the pandemic. These segments include offices, shopping malls and hotels, especially those that rely heavily on business and convention travelers.

The FDIC’s examination priorities apply only to banks supervised by the agency, which tend to be relatively small institutions. But many of these smaller banks have relatively large exposures to commercial real estate.

At the end of last year, FDIC-supervised banks held about 41% of the $2.7 trillion in commercial real estate loans held by banks.

In recent weeks, several regional banks have indicated that they are monitoring the sector for signs of weakness.

Fifth Third Bancorp in Cincinnati increased reserves in its commercial real estate portfolio last quarter, citing high risk. The bank is closely monitoring hotels in central business districts as well as office space, Chief Financial Officer Jamie Leonard said in an earnings call on July 21.

In a July 14 call, executives at First Republic Bank in San Francisco were asked about the weak market for office space in the Bay Area. In response, Chief Banking Officer Michael Selfridge said the First Republic had become more cautious, although he also noted that the bank was not in the business of lending on large high-rise buildings where interest rates occupation had suffered.

In its recent paper, the FDIC found that banks with higher concentrations in commercial real estate lending generally had higher pre-tax returns on average assets last year than all other banks. But those banks also tend to have a higher risk profile, the FDIC said, citing lower levels of capital and loan loss reserves.

The agency said it plans to continue its current supervisory approach for banks that have concentrations in commercial real estate lending.

“Regulators and banks have a long history with commercial real estate and mergers,” said Matthew Anderson, chief executive of analytics firm Trepp. “It’s been a topic for decades – sometimes with good reason.”

Commercial real estate loans were the main source of trouble for about 80% of the more than 400 banks that failed during and around the Great Recession, Anderson said.

“In this cycle, the impacts on real estate, at least so far, have been radically different,” he added.

Unlike the period before the 2008 financial crisis, the pre-pandemic period did not see a surge in construction lending, Anderson noted. Construction loans typically suffer large losses at the start of a downturn because unfinished properties do not generate income for borrowers.

At the start of the pandemic, hoteliers and brick-and-mortar retailers saw a sharp drop in business, which hurt their ability to repay their loans. But more recently, bank lending performance in these sub-sectors has started to improve, according to data from Trepp.

Delinquency rates on bank loans for accommodation peaked at 10.5% last year and have since fallen to 7.5%, according to Trepp’s TALLR database. Similarly, delinquency rates on bank loans for retail space peaked at 3.4% at the end of 2020 and have since fallen to 1.7%.

Meanwhile, delinquency rates on bank loans for office space rose steadily, from 0.2% in the fourth quarter of 2019 to 1.8% in the first quarter of this year. Many companies that rent office space have long-term leases. At a time when working from home has become commonplace, many of these businesses won’t need as much space when their leases come up for renewal.

“In the office, it’s a very slow leak,” Anderson said.