Bank Regulators Turn Up the Heat

NOTE TO READERS: The following article, authored by EDR Insight’s Dianne Crocker, was just published in the November 2016 edition of Scotsman Guide

Regulators Turn Up the Heat

Growing loan volume and relaxed underwriting spur credit-risk concerns

The market is in a good place as we near the end of 2016. Commercial real estate fundamentals, including property prices and vacancy rates, are favorable. Commercial property lending by financial institutions is growing. That’s the good news for commercial mortgage brokers and their clients, as well as for the market overall. The concerning news is that, coupled with this growth, federal regulators have become increasingly concerned about banks’ exposure to credit risk. The latest warning came from the Office of the Comptroller of Currency (OCC), and it provides evidence that regulators are keeping their focus squarely on banks’ risk management practices.

In the commercial property financing arena, market pressures to enhance growth and efficiency are now set against intense scrutiny by regulators. Given the growing market uncertainty as the year-end approaches, the focus on credit risk has important implications for today’s deal making environment.

Easing credit standards

Bank examiners have been vocal about lenders’ increased exposure to risk as they expand real estate portfolios at the expense of strong underwriting. The OCC, which oversees American banks alongside the Federal Reserve Board and the Federal Deposit Insurance Corp. (FDIC), recently released a report for the first half of 2016, called the Semiannual Risk Perspective.

The OCC report noted the increased risks associated with more commercial real estate lending — including office, retail and multifamily-housing construction. The last time the OCC sounded the alarm about rising concentrations and looser underwriting standards for commercial real estate loans was in the Interagency Statement On Prudential Risk Management for Commercial Real Estate Lending — issued in late 2015 in conjunction with the Federal Reserve Board and the FDIC.

With interest rates still low, commercial real estate portfolios have been on a growth path as lenders strive for volume and yield amid intense competition. Banks have been pushing to increase loan growth, particularly in the commercial real estate sector and especially among smaller banks. Consider these statistics from the OCC:

  • A total of 406 banks at year-end 2015 had three-year growth rates of 50 percent or more; and
  • A total of 180 banks among that group of 406 lenders more than doubled the size of their commercial real estate portfolios over the same period.

In the face oteapotf such growth, commercial real estate credit has risen among larger banks and community banks. What is concerning to the OCC is that the agency’s reviewers are finding evidence of loosening commercial real estate lending policies and practices in their examinations.

Thomas Curry, who heads the OCC, said strong loan growth combined with easing underwriting standards is leading to increased credit risk in commercial real estate portfolios — particularly among smaller lenders. Consequently, Curry said regulators are focused on concentration risk management.

In the area of commercial real estate lending, then, the OCC has raised a caution light. What it means is that if lenders are going to ease underwriting standards, they need to be able to demonstrate to examiners that they have an effective risk-management framework in place.

Technology platforms

Another type of risk that the OCC is monitoring is related to the increasing reliance on technology platforms in the mortgage industry. Compliance-risk management remains a complex area to manage and continues to pose challenges as banks and other mortgage professionals implement systems to address changes in technology and to comply with new rules.

Business operating models are under increasing pressure as banks leverage technology, implement systems to comply with new rules, reduce staffing, outsource critical activities, re-engineer business processes and partner with vendors unfamiliar with the bank-regulatory environment. As more banks seek efficiencies in complying with the growing regulatory requirements, many are adopting innovative approaches, including expanded reliance on third-party relationships, and updating or acquiring new information systems and technology platforms.

Technology platforms are growing in popularity as an effective means for banks to comply with regulatory requirements much more efficiently. The OCC wants to ensure, however, that banks are aware of the heightened strategic planning required and the governance-risk exposure they may face if they do not use sound risk-management practices when working with outside vendors.
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Regulators are being vocal in their warnings against credit-risk exposure related to aggressive underwriting as banks and the commercial mortgage brokers that work with them compete fiercely for creditworthy borrowers. These warnings are even more meaningful in the context of today’s market conditions.

The low interest rate environment that has contributed to active commercial-property lending is nearing its end, with a trend toward increasing interest rates likely on the horizon. In addition, speculation about the timing of the next cyclical downturn has already started, and there is no shortage of political and economic risk on the global stage. Amid such uncertainty, exercising caution and prudence in managing the credit risk associated with commercial real estate lending becomes increasingly important. finding evidence of loosening commercial real estate lending policies and practices in their examinations.


profilepic_May2016Dianne P. Crocker is the principal analyst at EDR Insight, which delivers strategic analytics, risk management best practices, market intelligence reports, educational seminars and customized research for stakeholders in commercial real estate deals. Crocker is an expert on environmental due diligence trends and is frequently invited to speak about commercial real estate and how real estate environmental risk is being managed. Before EDR, Crocker was an economic analyst at E.H. Pechan & Associates Inc. Reach her at