FDIC signals closer scrutiny of commercial real estate loans

Diving Brief:

  • The Federal Deposit Insurance Corp. (FDIC) will take a closer look at banks with high exposure to commercial real estate (CRE) loans, the agency announced last week, citing the economic impact of the COVID-19 pandemic.
  • Reviewers will focus more on testing CRE transactions in the next review cycle, “given the uncertain long-term impacts of changes in labor and commerce as a result of the pandemic, the effects of rising interest rates, inflationary pressures and supply chain issues,” the regulator said in its Supervisory Insights newsletter on Wednesday.
  • A closer look at commercial real estate loans comes as the volume of CRE loans held by banks peaked at more than $2.7 trillion at the end of 2021, the FDIC said.

Overview of the dive:

More than 98% of banks engage in commercial real estate loans, and commercial real estate loans are the largest type of loan portfolio for nearly half of all banks, the FDIC said in its report.

While dollar volume of CRE lending is at an all-time high and a growing number of banks are reporting concentrations of CRE, loan concentrations “are not by definition problematic,” the FDIC said.

“The majority of banks with concentrations of CRE loans are rated satisfactory. Nonetheless, CRE lending concentrations add risk dimensions that require continued attention from banks and their regulators, especially as the pandemic persists and uncertainties remain,” the regulator said.

While 2021 has seen an improvement in the commercial real estate market compared to 2020, the FDIC has highlighted some areas hard hit during the pandemic that have been slow to recover.

“[S]Some sectors, such as hospitality (especially business/convention oriented) and office, and some geographies, such as New York’s Manhattan borough, have lagged,” said the FDIC, which also referenced falling mall valuations. in 2021. “The impacts of the pandemic and other uncertainties remain poised to potentially affect CRE property values.”

The FDIC said its bank examiners found areas of concern in some banks’ CRE loans, including a lack of sufficient risk analysis, despite high risk profiles.

“Others have failed to meet board expectations for such testing and analysis in their policies,” the regulator said. “In addition, reviewers observed that the design and complexity of some testing or analysis methods were incompatible with the nature of CRE portfolios and lending environments.”

“These inconsistencies could ultimately weaken the usefulness of the results to the bank’s board and management,” the FDIC said.

As the FDIC focuses more on CRE loans, examiners will test new CRE credits, credits in stressed subcategories and geographies, and credits with payments vulnerable to rising rates and rising costs , the regulator said.