Portfolio diversification across property types. See also Interagency Guidelines Establishing Standards for Safety and Soundness: 12 CFR 364, appendix A (FDIC); 12 CFR 30, appendix A (OCC); 12 CFR 208, appendix D-1 (FRB); and 12 CFR 570, appendix A (OTS). CRE updates were released in 2012, along with community bank stress-testing guidance in 2013. Atlanta, GA, Mark D. Sheely Concentrations, as previously noted, mean higher inherent risk. Specifically, the agencies reiterated the need for strong risk management practices to comply with Supervision and Regulation (SR) letter 07-1, “Interagency Guidance on Concentrations in Commercial Real Estate.” 3 This guidance does not set limits on the size of CRE concentrations but instead highlights strong risk management practices that are necessary for a bank with a high CRE credit … This is especially true if the data for the reference portfolio lack granularity. This interagency supervisory guidance was developed to reinforce sound risk-management practices for institutions with high and increasing concentrations of commercial real estate loans on their balance … When compared to the current ratings, the effect of a market downturn could be measured (see Table 2). 1 Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, Federal Register, Vol. Level of pre-sold units or other types of take-out commitments on construction loans. If agreement with a high percentage of assigned credit ratings cannot be achieved, the rating guidelines may Transparency is generally evaluated by reading the bank’s rating policy guidelines and conducting transaction testing. "Adapting to CRE Concentration and Risk Management Guidelines" (April 2007) describes one bank's firsthand experience in incorporating the principles. "Regulatory Guidance on Commercial Real Estate Risk" (April 2007) explains the guidance and the seven key areas. Reserves for maintenance and improvements. History has clearly demonstrated that CRE can experience cyclical changes in which supply and demand get out of balance, resulting in significant losses for financial institutions. • Total commercial and residential real estate loans secured by real estate with LTVs in excess of FDICIA guidelines should not exceed 100% of capital. In response to rapid growth in CRE loan concentrations and observed weaknesses in risk management practices at some institutions, the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (FRB), and the Office of the Comptroller of the Currency (OCC) (collectively, the federal banking agencies) published Joint Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices (CRE guidance) in December 2006.1 This article provides additional information and context to some of the topics discussed in the CRE guidance, drawn from the authors’ firsthand observation of the risk management practices of both large and small banks. 238, December 12, 2006, pp. Columbia, MO, Tracy E. Fitzgerald FIL-104-2005, Joint Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices (, 12 CFR 365, Real Estate Lending Standards and Interagency Guidelines for Real Estate Lending Policies (, Interagency Appraisal and Evaluation Guidelines (, FIL-90-2005, Residential Tract Development Lending (, FIL-94-1999, Interagency Guidance on High Loan-to-Value Residential Real Estate Lending (. Information can be captured on mainframe systems or other systems—including the use of simple spreadsheets—but should be retained in a form that can be readily accessed for analysis purposes. Typical loan production and performance reports by type, region, officer, etc. The composition of a bank's real estate portfolio will vary based on differences in lending experience, market competition, and asset size. The guidance is not intended to limit banks' CRE lending, as the agencies recognize that banks serve a vital role in their communities by supplying credit for business and real estate development. A small, noncomplex bank may need only a one-dimensional rating system with a small number of rating grades, while a large or complex organization may require a rating system with more grades to measure risk levels adequately. Many de novo banks in areas with significant job and population growth (predominately in East and West Coast states) have used ADC loans as the primary asset class to drive growth and meet pre-opening projections. Real estate lending represents one of the major components of credit risk at many banks. Underwriting weakens to unreasonable levels or to levels banks previously would not have approved (e.g., deposits for qualifying presold condominium units are reduced by half to entice enough preconstruction buyers to demonstrate demand for a project). stress tests may be useful for planning purposes and to identify potential vulnerabilities. In addition to providing supervisory guidance regarding residential real estate lending, this subsection also contains guidance on subprime lending. Although most banks do not perform bankwide scenario stress testing, the process of developing such Reiteration of Interagency Guidance on CRE-Commercial Real Estate Concentrations has had limited impact on Banking Industry. The lending staff must pass along market information to the risk management function. The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation are jointly issuing the attached Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices (guidance). In 2006, the FFIEC published the Interagency Guidance “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” (1), which outlined regulators’ expectations for a risk management framework to manage the risk associated with Commercial Real Estate (CRE) concentrations. Total CRE loans as defined in the CRE guidance represent 300 percent or more of the institution’s total capital, and the outstanding balance of the institution’s CRE loan portfolio has increased by 50 percent or more during the prior 36 months. Adjusting those limits when market fundamentals change is also a prudent risk management tool. For example, the institution may create a CRE risk management function that is responsible for establishing CRE concentration risk limits (approved by the institution’s board) and overseeing compliance with those limits. Concentrations of credit exposures add a dimension of risk that compounds the risk inherent in individual loans. Following are examples of the types of stress tests commonly used in banks. Most geographic locations in the United States have not experienced serious declines in CRE markets for a number of years. Many institutions will want to expand the level of information captured to specifically include underwriting characteristics, such as LTVs, debt service coverage levels, speculative versus presold units, etc., to allow for more enhanced reporting and analysis. While the direct costs of these actions are apparent, there are often other costs that bear mention. A bank can have significant diversification within its CRE portfolio or have a concentration within a specific CRE category. If these data are not available, a bank might choose to apply conservative estimates of migrations to establish a stress year. Loan pricing becomes too thin for the underlying risk (e.g., construction loan pricing has fallen almost 150 basis points in recent years owing to competition). Learn if your bank is insured, view locations, track history, and more. Independence in the validation process At a minimum, the risk rating system should rank order risk in the portfolio and provide enough grades so that the vast majority of loans do not fall into just one grade. 3 The federal bank and thrift regulatory agencies have adopted substantially similar appraisal regulations. Additional costs accrue during the holding period, including property taxes and the cost of sales, maintenance, and security. 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