Commercial Real Estate –Now is the Time to Prepare

Susannah Marshall | Commissioner | Arkansas State Bank Department

In the past few articles, I have focused my comments on interest rate risk, deposit and funds management practices and concentrations on the liability side of a bank’s balance sheet. Now, I want to turn the conversation back to a topic that has been somewhat in the background in recent years; yet it is a subject that once again warrants our time and attention now and in the immediate future, Commercial Real Estate (CRE) concentrations. In recent months, regulators have again elevated their focus on CRE concentrations even as so much discussion has been directed to liquidity risk. I want to share with you a few thoughts regarding CRE concentrations so that your bank’s Board and Senior Management are prepared if your bank is engaged in this regulatory conversation.

As of March 31, 2023, the most recent aggregate data available, Arkansas reported 16 state-chartered banks (approximately 22%) with either non-owner occupied CRE concentrations in excess of 300% of Tier 1 Capital plus credit loss reserves, or acquisition, development, and construction loans in excess of 100% of Tier 1 Capital and credit loss reserves, and some institutions reported both concentrations. The numbers track somewhat close to our position in March 2009 where we had 31% of our Arkansas state banks reporting some type of CRE concentration. Many of us can vividly remember the 2009 timeframe which led to unprecedented levels of deterioration in CRE values further impacting Asset Quality and the overall health of banks both nationally and locally.

Now is the time to enhance risk management practices around CRE concentrations. Regulators have begun to escalate the reviews of institutions which hold CRE concentrations. A variety of factors are impacting CRE portfolios in today’s market: rising interest rates, unyielding inflation, uncertain pandemic revival concerning CRE utilization, declining real emphasizing credit risk within CRE concentrations. On June 29, 2023, the federal banking agencies issued the “Interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts.” This Statement replaces a 2009 Statement and will serve as a companion estate values in some markets and overall economic variability. Regulators want and need to know how bank management teams are identifying, measuring, monitoring, and controlling these known risks within loan portfolios and specifically CRE holdings. Further, conversations between regulators and bankers regarding CRE concentrations are beginning to occur more frequently and outside the scope of an examination. Preparedness is key in mitigating CRE concentration risks, as well as assuring regulators that your bank is actively managing its CRE concentration.

Additional communications have been sent to the industry as another indication that the regulatory agencies are to the long-standing, joint “Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” which was issued in December 2006. Further, at least monthly, I am reading an article with a theme around CRE market conditions and their future outlook or how banks can enhance their CRE concentration risk management practices. I remain positive about overall credit quality and loan portfolio performance as we begin the third quarter; however, I along with all banking regulators, remain keenly aware of the challenges that exist in this uncertain economic environment and the potential impacts these challenges present on the CRE portfolios of financial institutions.