Bank regulators hiking capital requirements for CRE-concentrated banks

An increasing number of US banks are finding themselves subject to heightened capital requirements as federal regulators zero in on commercial real estate.

Already on high alert following the large bank failures in 2023, recent events such as New York Community Bancorp Inc.'s woes as well as increasing commercial real estate (CRE) credit issues have regulators acting out of an abundance of caution. Banks with high CRE concentrations, and particularly those above the regulatory guidance to not exceed 300% of CRE to total risk-based capital, are being required to hold more capital.

It is unknown which banks are subject to heightened requirements because that is confidential supervisory information.

Among banks with the most CRE loans as a proportion of total loans, State Bank of Texas had the highest CRE concentration in the first quarter at 97.5% while NorthEast Community Bank had the second-highest at 94.2%.

Bank OZK, which recently found its stock under pressure following an analyst downgrade, was the largest bank among the top 20 with 74.3% of its loans in CRE in the first quarter.

Individual minimum capital ratio requirements

The Office of the Comptroller of the Currency (OCC) is increasingly making use of a rarely used tool in its regulatory toolbox to address CRE concerns. OCC-regulated banks with high CRE concentrations are finding themselves subject to individual minimum capital ratios (IMCRs), which typically require a leverage ratio between 9% and 10% and total capital ratio between 12% and 14% — above a leverage ratio of 4% and a total capital ratio of 8% to be considered adequately capitalized.

The OCC has long had this tool in its toolbox, but more recently it is increasingly using it to address CRE concentrations, advisers said.

"The capital requirements are directly tied to the amount of CRE loans that the bank has made," Brian Marek, partner at Hunton Andrews Kurth LLP who represents community banks and their holding companies on regulation and more, said in an interview. The higher "the concentration levels in CRE loans, the more capital that has been required by the OCC under these IMCRs."

Marek has seen two clients recently receive IMCRs but had not seen this before 2023.

One of his clients agreed to a two-tiered set of requirements, including having a 10% leverage ratio and 13% total capital ratio if its ratio of construction and development (C&D) loans to total capital is at or above 200% or if its ratio of nonowner-occupied CRE to total capital is at or above 400%. Additionally, it has to have a leverage ratio of 9.5% and 12.5% total capital if its ratio of C&D to total capital is at or below 199% or if its ratio of nonowner-occupied CRE to total capital is at or below 399%.

Another client made a similar agreement, Marek added.

"This, tailored specifically for commercial real estate concentrations ... has been relatively rare, and it's been relatively recent," he said. "The regulators are looking closely at commercial real estate concentrations in the context of: Does this present a potential safety and soundness issue for that particular bank? And if so, one of the tools that they may elect to use is an IMCR."

James Stevens, partner and co-leader of Troutman Pepper Hamilton Sanders LLP's Financial Services Industry Group, said in an interview that he has heard of IMCRs issued related to CRE concentrations or small, risky books.

What other agencies are doing

The OCC is not the only agency with higher expectations for banks with CRE concentrations.

Stevens said federal regulators are also engaging in other CRE enforcement activities, such as directing banks to reduce their CRE concentrations and boards to enhance portfolio monitoring.

Specifically, the 300% threshold for CRE loans to total risk based capital is front of mind for the agencies.

"I have heard that examiners are pressuring banks on the 300% CRE supervisory limit and that some banks with large CRE concentrations have been required to hold more capital in connection with merger approvals," Matthew Bisanz, a partner in Mayer Brown's financial services regulatory and enforcement practice, wrote in an email.

In the first quarter, 456 banks had a CRE loans to risk-based capital ratio above 300%.

Looking at the ratio of CRE loans to Tier 1 capital plus allowance for loan losses, Hingham Institution for Savings had the highest proportion in the first quarter at 623.1%, according to an S&P Global Market Intelligence analysis. The second-highest was HomeStreet Bank at 587.4%, which is set to be acquired by FirstSun Capital Bancorp.

In addition to individual ratios, regulators are focused on CRE concentrations and capital in potential mergers. Several recent bank deals have been announced in conjunction with capital raises, either due to regulatory mandates or banks' own decisions.

After announcing a capital raise in conjunction with the HomeStreet deal, First Sun now plans to raise more capital in conjunction with the deal and changed its regulatory tract for approval, largely related to CRE.

In some cases, regulators are requiring more capital, such as Provident Financial Services Inc.'s acquisition of Lakeland Bancorp Inc., which was approved with CRE concentration limits and a mandate to raise capital and retain higher capital levels.

CRE loans relative to leverage ratios

Regulators could be less concerned about a bank if it has a high leverage ratio, which measures Tier 1 capital to total consolidated assets, indicating a better ability to withstand losses.

Of CRE-concentrated US banks, the one with the highest leverage ratio in the first quarter was Legends West Bank at 32.67%, with Bank of New England in second at 17.94% and Founders Bank in third at 17.57%. They exceeded the regulatory guidance because their C&D loans made up at least 100% of Tier 1 capital plus allowance for loans and lease losses.

The regulatory criteria looks at whether banks exceed either of two thresholds, CRE loans at least 300% of risk-based capital levels with growth of at least 50% over the past 36 months or construction (C&D) loans at least 100% of risk-based capital.

The CRE-concentrated US bank with the lowest leverage ratio was Spectra Bank at 5.58%, and third-lowest was Sterling State Bank at 6.59%, both of which exceeded the CRE concentration and growth criteria but not the C&D concentration limit. On the other hand, Nantahala Bank & Trust Co. had the second-lowest ratio at 6.42%, and it exceeded the C&D concentration guidance but not the CRE criteria.