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Federal Reserve Limits Commercial Real Estate Financing

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This hasn't gotten much play yet, but the Federal Reserve Board issued new guidance aimed at stemming commercial real estate finance.

The Board says it is concerned about the high amount of commercial real estate debt on bank balance sheets--particularly for smaller and mid-sized institutions. It also admits it is trying to avoid a repeat of the meltdown of the late 1980s and 1990s, when "regulated financial institutions suffered losses from their real estate lending activities due to weak underwriting standards and risk management practices."

From the introduction to the guidance:

The Agencies have observed that commercial real estate (CRE) concentrations have been rising over the past several years and have reached levels that could create safety and soundness concerns in the event of a significant economic downturn. To some extent, the level of CRE lending reflects changes in the demand for credit within certain geographic areas and the movement by many financial institutions to specialize in a lending sector that is perceived to offer enhanced earnings. In particular, small to mid-size institutions have shown the most significant increase in CRE concentrations over the last decade. CRE concentration levels1 at commercial and savings banks with assets between $100 million and $1 billion have doubled from approximately 156 percent of total risk-based capital in 1993 to 318 percent in third quarter 2006. This same trend has been observed at commercial and savings banks with assets of $1 billion to $10 billion with concentration levels rising from approximately 127 percent in 1993 to approximately 300 percent in third quarter 2006.

As such, the guidance looks to limit what it construes as the most risky loans--those where loans values exceed 100 percent of project costs:

The first proposed threshold stated that if loans for construction, land development, and other land were 100 percent or more of total capital, the institution would be considered to have a CRE concentration and should have heightened risk management practices. Secondly, if loans for construction, land development, and other land and loans secured by multifamily and nonfarm nonresidential property (excluding loans secured by owner-occupied properties) were 300 percent or more of total capital, the institution would also be considered to have a CRE concentration and should employ heightened risk management practices.

The full guidance can be downloaded as a pdf.

(Story via Real Estate Bloggers)

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Elaine Misonzhnik

Senior associate editor Elaine Misonzhnik has been writing for National Real Estate Investor since June 2006 and has covered commercial real estate for more than 12 years. She first became...
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