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KBW: Reg focus on CRE could drive some M&A

Theincreasing focus of federal regulators on risks and concentrations incommercial real estate could help drive M&A action in the banking industry.

Bankswith CRE concentrations greater than 300% of their capital — a key threshold asregulators ramp up their focus on the space — could face an important strategiccrossroads and will have just a few options to respond, KBW analysts said July12.

"Youcan slow growth — and we have seen that across the industry CRE credit is notgrowing at the same rate, you could [be forced] to raise capital, or you couldsell," Chris McGratty, a managing director who covers small and mid-capbanks, said during a discussion of the post-Brexit outlook for the bankingindustry.

SlowingCRE asset growth to satisfy regulators, and in turn likely seeing reducedprofitability, could itself motivate some banks to sell, he added. Banksrefilling their capital coffers would be "episodic," according toMcGratty, but "generally there will be more M&A activity."

Risksin commercial real estate lending have come under increasing focus amongfederal regulators in recent months. The OCC said in its semiannual riskperspective that poor CRE underwriting amid rapid growth of CRE balances is aworry. "Our exams found looser underwritingstandards with less-restrictive covenants, extended maturities, longerinterest-only periods, limited guarantor requirements and deficientstress-testing practices," Comptrollerof the Currency Thomas Curry said during a discussion of the OCC's report.

Those warnings come about six months after federal regulators a joint interagencystatement reiterating oversight guidelines. The agencies said at the time thatbank examiners would pay special attention to CRE underwriting and riskprocesses, and that they could ask some banks with concentrations or other riskshortcomings to bolster capital levels.

Riverhead, N.Y.-based SuffolkBancorp agreed to a $402 million sale to latelast month. The bank had warned just months earlier that it expected regulatorsto establish higher minimum capital ratios for it and announced that it was nolonger making multifamily loans in New York City because of worries about themarket.

Theanalysts said that they were reducing earnings estimates for many of theircovered names in the bank space after the Brexit vote, as the reduced chancesof a rate hike in the second half of 2016 means they are likely to face a "lowerfor longer" interest rates environment that will compress net interestmargins.

Thatenvironment could be somewhat beneficial for banks who operate in the CREspace, Director of Research Frederick Cannon said, because low yields havehelped drive valuations for U.S. CRE higher. With worries about valuationsnearing cyclical highs, the continued need to find yield could provide ajustification for CRE pricing and support the market, according to Cannon.