A proposal by federal regulators to more closely scrutinize banks with large concentrations of commercial real estate (CRE) loans and raise capital requirements threatens to choke a lucrative lending sector, industry leaders say.
“By using blanket industry-wide guidance to address concentrations that the regulators are seeing at some banks, the regulators risk choking off the flow of credit from banks that are engaging in CRE lending in a safe, sound, and profitable manner,” banker Harris Simmons told members of the House Subcommittee on Financial Institutions and Consumer Credit on Sept. 14. Simmons is CEO of Zions Bancorporation in Salt Lake City and chairman of the American Bankers Association.
As proposed, new regulations would set thresholds calling for enhanced risk management programs and greater capital requirements when a bank’s concentration of construction lending grows larger than 100% of a bank’s total assets, or when all CRE loans exceed 300% of capital.
While the proposed thresholds are intended to alert banks to the need for rigorous risk management programs to monitor high loan concentrations, lenders and real estate industry representatives say that analysts and bank examiners could interpret the 100% and 300% thresholds as lending caps.
Several agencies, including the Office of the Comptroller of the Currency (OCC), 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 fear a repeat of the widespread commercial real estate failures that contributed to bank and savings-and-loan failures two decades ago.
Approximately 35% of U.S. banks today have CRE loans equal to more than 300% of their capital. That’s nearly double the 169% CRE loan concentration for community banks in 1989, according to the comptroller’s office.
“One bank has commercial real estate loans that represent 750%, or 7.5 times, its capital,” Rep. Maxine Waters, D-Calif., told the subcommittee. “Is this prudent banking practice, or is it inherently risky?” Waters’ example was intended to show the potential for overexposure to real estate, yet it lends equal weight to the lending industry’s main complaint about the proposed regulations — that banks with risk management programs inadequate for their CRE loan concentrations are best dealt with on a case-by-case basis, rather than through industry-wide regulations.
“The regulators have an ample supply of supervisory and enforcement tools at their disposal to address any bank that is failing to manage adequately the risks presented by a CRE concentration,” Simmons of the American Bankers Association testified. “If, in fact, the regulators are seeing concentrations at only some banks, then the supervisory response should be tailored to fit the particular facts of a given bank.”
Opponents of the new regulations say the broad-brush approach is too simplistic for a market sector that employs a spectrum of diversification strategies by geography, product type and other factors. Today’s commercial real estate market benefits from greater transparency, increased scrutiny and more timely information than in years past due to the influence of public real estate investment trusts and the creation of the commercial mortgage-backed securities market, according to Bob White, president of Real Capital Analytics. “The information feedback loop that is now in place should help prevent large boom-bust cycles in the future,” White told subcommittee members.
Lawmakers at the hearing seemed hesitant about the proposed guidelines, White says. If the rules are adopted, real estate and banking leaders worry that even those lenders that do meet enhanced risk-management guidelines will see their share prices suffer, if they exceed the new thresholds for CRE loan concentrations.
“The pace of construction right now is about $1.2 trillion [annually], which doesn’t include land or other things that need to be financed,” White says. “There’s a real potential that even that 100% threshold could effectively cap construction levels below what we need.”