Photo by Matthew G. Bisanz | CC BY-SA 3.0

With banks holding record volumes of commercial real estate loans, the FDIC plans to increase its focus on CRE transaction testing during its next cycle of bank examinations.

In its Supervisory Insights bulletin last week, the FDIC pointed to effects on CRE loans from “the uncertain long-term impacts of changes in work and commerce in the wake of the pandemic, the effects of rising interest rates, inflationary pressures, and supply chain issues.”

Banks ended 2021 with record CRE loans totaling more than $2.7 trillion, the FDIC said, and community banks had $795.7 billion in CRE loans.

Massachusetts had 5,084 commercial mortgages from January through June of 2022 worth $44.2 billion, a 65 percent increase in loan volume compared to the 5,107 loans worth $26.6 billion made in the first six months 2021, according to The Warren Group, publisher of Banker & Tradesman.

More banks at the end of 2021 also reported higher concentrations in CRE loans, including those with a certain concentration in construction, land development and other land, as well as banks with a certain concentration of CRE loans that have also seen the portfolio increase by 50 percent or more during the prior 36 months.

The FDIC said lending concentrations are “not by definition problematic,” and noted that these concentrations are sometimes necessary for smaller banks.

“The majority of banks with CRE loan concentrations are satisfactorily rated,” the FDIC said. “Nevertheless, CRE loan concentrations add dimensions of risk that necessitate continued attention from banks and their regulators, especially as the pandemic lingers and uncertainties remain.”

The FDIC said CRE loan delinquencies are at historically low levels, while loan losses have been nominal, partly because of government aid during the pandemic and low borrowing costs. Banks have also worked with borrowers experiencing stress during the pandemic, the FDIC said, likely limiting losses as borrowers had time and flexibility to address issues.

But bank examiners have noted concerns during recent examinations. Some concerns involve underwriting, including using outdated financial information that might include pandemic aid when assessing capacity to repay a loan. Other observations included banks with risk-rating frameworks that lacked objective criteria, insufficient tracking of policy exceptions, and insufficient risk analysis when stress-testing loan portfolios.

As the FDIC moves into the 2022-23 examination cycle, the agency said it would continue to recognize factors such as the effects of the pandemic.

“Examiners will consider the unique, evolving, and potentially long-term nature of the issues confronting banks in developing their supervisory response,” the FDIC said.

The FDIC will also consider how a bank’s management team assesses risks related to the pandemic, while keeping in mind the bank’s size, complexity and risk profile.

“When assessing management, examiners will consider management’s effectiveness in responding to the changes in the bank’s business markets and whether management’s longer-term business strategies address these changes,” the FDIC said.

Examinations will now include an increased focus on CRE transaction testing. The FDIC said it plans to test newer CRE credits, credits within stressed sub-categories and geographies, and credits with payments that are vulnerable to rising rates and costs.

FDIC to Increase Scrutiny of Banks’ CRE Lending

by Diane McLaughlin time to read: 2 min