Author(s): Kristine L. Poston
Published: 09/22/2009
Federal bank regulation guidance issued back in 2006 is creating new problems for commercial real estate ("CRE") developers and the financial institutions attempting to grant those developers new loans and extensions on existing loans. As a result, many real estate developers have been forced to default and turn property over to their banks.
The current problem stems from the issuance of final guidance via press releases circulated in December of 2006 addressing high concentrations of CRE loans. The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (the "Federal Banking Agencies") jointly stated that the intention of the guidance was to "help ensure that institutions pursuing a significant CRE lending strategy remain healthy and profitable while continuing to serve the credit needs of their communities." At the time, the Federal Banking Agencies were concerned that rising CRE loan concentrations in small- to medium-sized banks would expose institutions to "unanticipated earnings and capital volatility in the event of adverse changes in commercial real estate markets."
As part of the Federal Banking Agencies' supervisory monitoring process, the agencies announced they would use specific criteria to identify categories of financial institutions with what the agencies considered dangerously high CRE concentrations. An institution falling into one of the following categories could be subject to further supervisory analysis of the level and nature of its CRE concentrations risk and to substantially increased capital requirements:
- An institution that has experienced rapid growth in CRE lending
- An institution that has notable exposure to a specific type of commercial real estate
- An institution whose total reported construction, land development, and other land represents, approaches, or exceeds 100% or more of the institution's total capital
- An institution whose total CRE loans represent, approach, or exceed 300% or more of the institution's total capital, and the outstanding balance of the institution's CRE loan portfolio has increased by 50% or more during the prior 36 months
While the criteria listed above were not necessarily meant to represent "limits" on an institution's lending activity, as a result of the severe national economic downturn, financial institutions and regulators have recently begun to strictly interpret the guidance. This change has forced bankers to tighten internal loan approval and underwriting standards.
Specifically, in order to keep CRE lending to under 300% of an institution's total capital, banks need their CRE borrowers to pay off their loans, and are therefore hesitant to offer extensions. Some banks are seeking to raise private capital as a second way to keep their percentage of commercial real estate under the recommended threshold. Unfortunately, when private equity is not readily available and banks are required to shrink their CRE portfolios, CRE developers and homebuilders feel the greatest impact.
Bottom Line
The CRE concentration risk categories were never meant to represent a bright-line limit on an institution's lending or a "safe harbor" for institutions to hide under if other risk indicators are present. In assessing the adequacy of an institution's capital, the Federal Banking Agencies will consider the level and nature of inherent risk in an institution's CRE portfolio as well as management expertise, historical performance, underwriting standards, risk management practices, market conditions, and any loan loss reserves allocated for CRE concentration risk. In reality, banks all answer to their regulators, who recently have been severely and uncompromisingly negative in their view of CRE loans.
The Federal Banking Agencies' guidance described above can be found at http://www.fdic.gov/news/news/press/2006/pr06114a .html. Please contact your attorney with specific questions.
Kristine Poston's practice at RJ&L focuses on real estate and corporate law. She advises and represents corporations, developers, individuals, financial institutions, and buyers and sellers in real estate purchase transactions. Ms. Poston also represents borrowers and lenders in real estate financing transactions. She can be reached at 303-628- 9538 or by email at kposton@rothgerber.com.