New federal guidelines on prudent concentrations of real estate loans represent a compromise with commercial real estate industry representatives who were concerned the new rule would expose lenders to unwarranted restrictions by bank examiners and analysts.
Earlier this month, The Office of the Comptroller of the Currency (OCC), the board of governors of the Federal Reserve System and the Federal Deposit Insurance Corp. (FDIC) issued the final Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices.
The rule reinforces risk management procedures already in place for federal banks and provides supervisory criteria to assist in identifying institutions with potentially significant commercial real estate loan concentrations.
As originally proposed, regulations would have set thresholds calling for enhanced risk management programs and greater capital requirements when a bank’s concentration of construction lending grew larger than 100% of the banks’ total assets, or when all commercial real estate loans exceeded 300% of its capital. While the proposed thresholds were intended to alert banks to the need for rigorous risk management programs to monitor high loan concentrations, lenders and real estate industry representatives told agency representatives that the 100% and 300% thresholds could have been treated as lending caps by analysts and bank examiners.
The adopted rule retains the 100% and 300% criteria, but unlike earlier incarnations, doesn’t treat those thresholds as de facto evidence that enhanced risk management is required. As written, concentrations in excess of those amounts may merit further scrutiny, which may or may not reveal a need for enhanced risk management programs and capital reserves.
Several agencies, including the Office of the Comptroller of the Currency (OCC), had proffered the rule change in January in response to a rapid increase in real estate lending: Commercial loans made in 2005 totaled $1.3 trillion, up 16% from the previous year, according to the OCC. Federal regulators feared a repeat of the widespread commercial real estate failures that contributed to bank and savings-and-loan failures two decades ago.
Opponents of the previously proposed regulations say the broad-brush approach was too simplistic for a market sector that employs a spectrum of diversification strategies by geography, product type and other factors.