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Regulators'focus on commercial real estate concentrations just might encourage some banksto raise capital, and reward others with more attractive rates on newlyoriginated credits.
Theregulatory community stated in December 2015 that they planned to pay"special attention" to banks with higher commercial real estateconcentrations, reminding institutions of guidance issued in 2006. Regulatorswarned late in 2015 that they are taking a harder stance on concentrations dueto concerns about credit risk building in the industry.
Regulatorsdefined those concentrations as CRE loans making up at least 300% of totalrisk-based capital; construction, land development and other land loanscomprising 100% or more of total risk-based capital; and construction and totalCRE growth of 50% or more over the prior 36 months.
Twoinstitutions brought the issue in focus in recent weeks. that it expected the OCC toestablish individual minimum capital ratios that would require the bank tomaintain a Tier 1 leverage ratio of at least 9%, a Tier 1 ratio of at least 11%and a total capital ratio of at least 12%, well above the well-capitalized ratiominimums of 5%, 8% and 10%, respectively.
Suffolksaid that it satisfied the higher capital ratios at March 31, though could notguarantee that it would going forward. Suffolk further noted that it has seenworrisome signs of markets becoming overheated and stopped accepting newapplications for multifamily loans in New York City several weeks ago. Suffolksaid it is working to target growth in non-CRE loans, while exploring optionsto ensure that it remains compliant with the higher capital requirements,including possible sales of securities and multifamily loans.
Aroundthe same time, First of LongIsland Corp. disclosed that regulators' increased concern about commercialreal estate concentrations was among the challenges it faces. Like Suffolk,First of Long Island had a CRE concentration exceeding 300% of risk-adjustedcapital and had reported CRE growth in excess of 50% over the past 36 months.Shortly after reporting earnings, the company a common equity capital raise,and said the proceedswould be used for general corporate purposes, including organic growth andpossible acquisitions of branches or fee-based businesses.
Banksoperating above CRE concentrations highlighted in the regulatory guidance mighthave to take actions to bolster their balance sheets. Operating above thestated CRE concentrations, however, will not necessarily require an institutionto raise more capital. Banks seem to be evaluated on a case-by-case basis, andcan operate with higher concentrations as long as they demonstrate robust riskmanagement practices, including conducting regular appraisals, analyzingborrowers' ability to repay credits, evaluating local economic conditions, andoperating with enhanced reporting and systems.
BMOCapital Markets analyst Lana Chan noted that Suffolk and First of Long Islandare both OCC-regulated banks, causing some investors to think that the OCC willbe harder on banks than other regulators. But Chan expects regulators to alignon the issue based on a recent conversation with a senior examiner at the FDIC.
"Webelieve, given the spirit of an inter-agency guidance, that it will be appliedacross all banks, no matter the primary regulator. To date, the OCC may just beahead of the FDIC in notable examinations, but it is not necessarily thetougher regulator," the analyst wrote in a May 5 report.
Broadapplication, whether it exists today or not, likely would please some banks.BankUnited Inc.,which is approaching the 300% CRE concentration level as it grows, noted duringits first-quarter earningsconference call that other banks not regulated by the OCC operatewith far higher CRE concentrations. BankUnited COO Rajinder Singh said thecompany speaks with the OCC regularly about the issue, and believes all theother agencies will take a similar approach to the 300% guidance.
"Thisguidance has been out from the OCC for probably 10 years, if not more, so it'sbeen around for a long time. But in the last year or so, we've been hearingmore that there's more dialogue between the various agencies to get to the sameplace of 300%. So, hopefully over the next few quarters, we'll see that,"Singh said on the call, according to the transcript.
BankUnitedsaid during the call that it is "working furiously" to develop andimplement the proper risk framework to move the 300% concentration level.
Otherbankers have noted that there is no prohibition on growing CRE balances abovethe regulatory guidance as long as the institution can clearly show that itunderstands the risk in its loan portfolio. Renasant Corp. executives noted May 3 at the Gulf SouthConference that no matter the institution's concentration limits, the importantpart is understanding what lies its loan portfolio and markets. They said thatany bank moving above the thresholds laid out in the guidance clearly willreceive more attention from regulators. Renasant CFO Kevin Chapman noted thatthe company was pleased that regulators were putting CRE risks under the spotlightbecause it had seen asset pricing inflation and less collateral in deals.
Otherbankers at the Gulf South event also applauded the heightened regulatory focuson CRE loans, and noted that the new regulatory treatment of certain CRE loansdeemed high-volatility commercial real estate is actually giving them acompetitive advantage. The high-volatility commercial real estate or HVCREclassification was introduced in the Basel III rules and became effective Jan.1, 2015. The rule states that to be exempt from the designation borrowers who originatecommercial acquisition, development and construction loans much meet a 15%equity requirement, and the leverage on such loans cannot exceed aloan-to-value of 80%. If those conditions are not met, qualifying loans will besubject to a 150% risk weight requirement, well above the 100% risk-weightunder the previous requirement.
Bankersat the Gulf South conference said the new treatment of HVCRE loans is improvingpricing in their markets. UnitedCommunity Banks Inc. President COO H. Lynn Harton said the focus onHVCRE is a "good regulation."
"Alittle bit better playing in the sandbox since that came out," Harton saidat the conference.
Renasantexecutives said at the Gulf South event that the market is now recognizing anycredit classified as HVCRE needs to be priced accordingly. Some deals in thecompany's market that would qualify as HVCRE were recently priced at premiumsto other CRE loans in its portfolio, they said.
ChairmanJohn Allison told a similar story, noting that some customers that previouslyreceived a loan at 5% now will be charged 7.5% to 8% to account for the higherrisk-weighting of the credit. Allison believes the regulation has leveled theplaying field and is a positive for the banking industry, stating that it will"change the world."