CUNA Regulatory Comment Call

March 20, 2006

Bank and Thrift Agency Guidance on Commercial Real Estate Lending


  • The federal bank and thrift regulators -- the Federal Reserve Board, Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), and Office of Thrift Supervision (OTS) -- have issued proposed guidance on sound risk management practices for concentrations in commercial real estate (CRE) lending (Guidance). The Guidance reinforces existing regulations and guidelines for a safe and sound CRE lending program. In addition, the Guidance provides criteria for identifying institutions with CRE loan concentrations that may warrant greater supervisory scrutiny.

  • In the proposal, the agencies indicate that some institutions have high and increasing concentrations of CRE loans where repayment primarily is dependent on rental income or from the proceeds of the sale, refinancing, or permanent financing of the property. Credits to real estate investment trusts as well as unsecured loans to developers are also cited, as they closely track the inherent risks in CRE lending. The agencies note, “Recent examinations have indicated that the risk management practices and capital levels of some institutions are not keeping pace with their increasing CRE concentrations.” In particular, the agencies are concerned that minimum levels of regulatory capital do not provide institutions with sufficient buffer to absorb unexpected losses in the event of a downturn in the cyclical CRE market.

  • The proposed Guidance would consider a bank or thrift at risk if:
    1) Its total loans in construction, land development or other land represent 100% or more of its capital.
    2) If total loans secured by multifamily and nonresidential properties and loans for construction, land development, and other land exceed 300% of capital.

  • If a bank or thrift exceeds one of these thresholds, then the regulators would want it to have capital beyond normal regulatory minimum requirements and commensurate with the level of risk in their CRE lending portfolios. However, the proposed Guidance does not specify how much additional capital a bank or thrift would have to hold. In addition, the institution would be expected to have robust risk management plans in place.

  • The guidance would exclude loans secured by owner-occupied properties, because the risk profiles of such loans are less influenced by the condition of the general CRE market. But the guidance does not say what percentage of a building would have to be owner-occupied in order for the loan to be excluded. Many banks would probably fall below the 300% threshold with the owner-occupied real estate exception.

  • Comments are due to the banking and thrift agencies by April 13, 2006 (the deadline was extended from March 14, 2006). Please send your comments to CUNA by April 6, 2006. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at or to Senior Regulatory Counsel Catherine Orr at; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004. You may also contact us at 800-356-9655, ext. 6743, if you would like a copy of the proposed guidelines, or you may access them at the following Internet address:


    Identification of Institutions With CRE Concentrations

  • As a preliminary step to determine whether it has a CRE concentration that warrants increased risk management practices, a bank or thrift should determine if it exceeds or is rapidly approaching the following thresholds:
    1) Its total loans in construction, land development or other land represent 100% or more of its capital.
    2) If total loans secured by multifamily and nonresidential properties and loans for construction, land development, and other land exceed 300% of capital.

  • A banks or thrift that exceeds the first threshold would be considered to have a concentration in CRE construction and development loans. The institution would be expected to have heightened risk management practices in place appropriate to the degree of concentration risk in its CRE portfolio.

  • A bank or thrift that exceeds the second threshold would be required to quantify the dollar amount of CRE loans in loan portfolio. If the bank of thrift meet or exceeds the 300% figure, then it should have appropriately heightened risk management practices.

    Risk Management Principles

    Board and Management Oversight

  • The bank or thrift’s board of directors, or a committee thereof, should explicitly approve the overall CRE lending strategy and policies of the institution.

  • The board should receive reports on changes in CRE market conditions and the institution’s CRE lending activity that identify the size, significance, and risks related to CRE concentrations.

  • Directors should provide clear guidance to management regarding the level of CRE exposures acceptable to the institution. The board should also ensure that senior management implements the procedures and controls necessary to comply with adopted policies.

  • The board should periodically review and approve CRE aggregate risk exposure limits and appropriate sublimits to conform to any changes in the institution’s strategies and to respond to changes in market conditions.

  • Directors should also make certain that management compensation policies are compatible with the institution’s strategy and do not create incentives to assume unintended risks.

  • Management should develop and implement policies, procedures, and limits that provide for adequate identification, measurement, monitoring, and control of the CRE risks, consistent with the institution’s stated risk tolerance.

  • Banks and thrifts should adhere to the agencies’ real estate lending regulations require that each institution adopt and maintain a written policy that establishes appropriate limits and standards. The Interagency Guidelines for Real Estate Lending Policies state that loans exceeding the interagency loan-to-value (LTV) guidelines should be recorded in the bank’s records and the aggregate amount of loans exceeding the LTV guidelines reported to the board at least quarterly. Further, the agencies’ appraisal regulations and related guidance require that each institution have an effective real estate appraisal and evaluation program that adequately supports its CRE lending activity.

    Strategic Planning

  • An institution’s strategic plan should address the rationale for its CRE concentration levels.

  • The institution should perform an analysis of the potential effect of a downturn in real estate markets on both earnings and capital.

  • The strategy should also include a contingency plan for responding to adverse market conditions. The contingency plan should address possible actions for mitigating CRE concentration risk and ensuring the adequacy of capital and reserves. If management believes the institution could reduce its CRE exposure by selling exposures, it should assess the marketability of the portfolio.


  • A bank or thrift’s lending policy guidelines should be based on a careful review of internal and external factors that affect the institution, such as its market position, historical experience, present and prospective trade area, probable future loan and funding trends, staff capabilities, and technology.

  • Consistent with the real estate lending standards of the agencies, underwriting standards should include standards for:
    • Maximum loan amount by type of property;
    • Loan terms;
    • Pricing structures;
    • LTV limits by property type;
    • Requirements for feasibility studies and sensitivity analysis or stress-testing;
    • Minimum requirements for initial investment and maintenance of hard equity by the borrower; and
    • Minimum standards for borrower net worth, property cash flow, and debt service coverage for the property.

  • Credit analysis should reflect both the borrower’s overall creditworthiness and project-specific considerations.

  • When an institution’s underwriting standards are substantially more lenient than those in the secondary market, management should justify the reasons why the institution’s risk criteria deviate from those of the secondary market and should document their long-term plans for these credits.

  • For development and construction loans, the institution should have sound policies and procedures governing loan disbursements to ensure that disbursements do not exceed actual development and construction costs.

  • An institution’s lending policies should permit exceptions to underwriting standards only on a limited basis. When an institution does permit an exception, it should document how the transaction does not conform to the institution’s policy or underwriting standards, obtain appropriate management approvals, and provide reports to the board of directors detailing the number, nature, justifications, and trends for exceptions in a timely manner.

    Risk Assessment and Monitoring of CRE Loans

  • Banks and thrifts should establish and maintain policies that specify requirements and criteria for risk rating CRE exposures, ongoing account monitoring, identifying loan impairment, and recognizing losses.

  • An institution’s internal rating systems should consider an assessment of a borrower’s creditworthiness and of an exposure’s estimated loss severity to ensure that both the risk of the obligor and the transaction itself are clearly evaluated. When assigning risk ratings to CRE loans, an institution should consider the property’s sensitivity to changes in macro and project-specific factors including variations in vacancy and rental rates, interest rates, and inflation rates.

  • Policies should address the ongoing monitoring of individual loans, including the frequency of account reviews, updating of borrower credit information, and status of leasing.

  • Policies should require periodic comparisons of actual property performance information with projections at the time of original underwriting and the appraisal assumptions to determine if any credit deterioration or value impairment has occurred.

  • Policies should specify the frequency with which transaction risk ratings should be reviewed to ensure they appropriately reflect the transaction’s level of credit risk.

    Portfolio Risk Management

  • An institution should measure and control CRE credit risk on a portfolio basis by identifying and managing concentrations, performing market analysis, and stress testing.

    Management Information System (MIS)

  • Institutions are encouraged, on either an automated or manual basis, to stratify the portfolio by property type, geographic area, tenant concentrations, tenant industries, developer concentrations, and risk rating.

  • Management reporting should be timely and in a format that clearly shows changes in the portfolio’s risk profile, including risk-rating migrations.

  • The MIS should provide management with the ability to conduct stress test analysis of the CRE portfolio for varying scenarios.

  • There should also be a formal process through which management reviews and evaluates concentration and risk management reports, as well as special ad hoc analyses in response to market events.

    Identifying and Managing Concentrations

  • An institution should combine and view as concentrations any groups or classes of CRE loans sharing significant common characteristics and similar sensitivity to adverse economic, financial, or business developments.

  • Using established limits relevant to its lending strategy and portfolio characteristics, an institution should monitor and control its CRE concentrations. Institutions are encouraged to consider other credit exposures correlated to the CRE market such as commercial mortgage-backed securities.

  • Institutions with high levels of construction and development loans should closely monitor market conditions particularly when relying on permanent loan take-outs as a way of managing concentration levels.

    Market Analysis

  • Institutions should perform ongoing evaluations of the market conditions for the various property types and geographic areas or markets represented in their portfolio.

  • In making decisions about new markets and new originations, market analysis should be an important evaluation criterion for individual credits as well as for the portfolio. Institutions should utilize multiple sources for obtaining market information such as published research data, monitoring new building permits, and maintaining contacts with local contractors, builders, real estate agents, and community development groups.

    Portfolio Stress Testing

  • Institutions should consider performing portfolio level stress tests of their CRE exposures to quantify the impact of changing economic scenarios on asset quality, earnings, and capital.

  • The sophistication of stress testing practices should be consistent with the size and complexity of the institution’s CRE loan portfolio. Depending on the risk characteristics of the CRE portfolio, it may be appropriate for a stress test to be as simple as an aggregation of the results of individual loan stress tests, testing the impact of ratings migration, or applying stressed historical loss rates to the portfolio.

  • Stress tests should focus on the more vulnerable segments of an institution’s CRE portfolio, given the prevailing market environment and the institution’s business strategy.

    Allowance for Loan Losses

  • Institutions also should consider CRE concentrations in their assessment of the adequacy of the allowance for loan and lease losses (ALLL). For guidance, institutions can refer to the Interagency Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions. Capital Adequacy

  • An institution with a CRE concentration should recognize the need for additional capital support for CRE concentrations in its strategic, financial, and capital planning, including an assessment of the potential for future losses on CRE exposures.

  • In performing its internal capital analysis, an institution should use of the results of any stress testing and other quantitative and qualitative analysis.

  • In assessing the adequacy of an institution’s capital, the agencies will take into account analysis provided by the institution as well as an evaluation of the level of inherent risk in the CRE portfolio and the quality of risk management. Supervisory Examination and Action

  • An institution that is unable to adequately assess and meet its capital needs may be required to develop a plan for reducing its concentrations or for achieving higher capital ratios.


    1. Do you feel that the proposed definition of an institution “at risk” is appropriate?

      Yes ______ No ______

      If not, what definition would you propose and why?

    2. Under the proposal, the burden would be on the bank or thrift to show that the amount of owner-occupied real estate in their portfolio brings their ratios below the thresholds. Do you agree with this?

      Yes ______ No ______

      If not, why not?

    3. Do you think the board and management responsibilities for oversight are adequate?

      Yes ______ No ______

      If not, please explain why not?

    4. The proposed Guidance states that management should compare the institution’s underwriting standards for individual property types with those that exist in the secondary market. Do you agree with the underwriting standards (Is the secondary market the appropriate comparison)?

      Yes ______ No ______

      If not, what are your suggestions?

    5. Do the stress testing requirements make sense?

      Yes ______ No ______

      If not, why not?

    6. The language in the proposed Guidance about requiring a bank or thrift to hold additional capital over the regulatory minimum is vague. The Guidance indicates that when evaluating the sufficiency of the institution’s capital, the regulators would consider analysis provided by the institution as well as an evaluation of the level of inherent risk in the CRE portfolio and the quality of risk management. Do you feel an objective standard is necessary?

      Yes ______ No ______

      Please explain.

    7. Other comments?

    Eric Richard • General Counsel • (202) 508-6742 •
    Mary Mitchell Dunn • SVP & Deputy General Counsel • (202) 508-6736 •
    Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 •
    Lilly Thomas • Assistant General Counsel • (202) 508-6733 •
    Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 •