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[Federal Register: December 12, 2006 (Volume 71, Number 238)]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
[Docket No. 06-14]
FEDERAL RESERVE SYSTEM
[Docket No. OP-1248]
FEDERAL DEPOSIT INSURANCE CORPORATION
Concentrations in Commercial Real Estate Lending, Sound Risk
AGENCIES: Office of the Comptroller of the Currency, Treasury (OCC);
Board of Governors of the Federal Reserve System (Board); and Federal
Deposit Insurance Corporation (FDIC).
ACTION: Final guidance.
SUMMARY: The OCC, Board, and FDIC (the Agencies) are issuing final
joint Guidance on Concentrations in Commercial Real Estate Lending,
Sound Risk Management Practices (Guidance). This Guidance has been
developed to reinforce sound risk management practices for institutions
with high and increasing concentrations of commercial real estate loans
on their balance sheets. This Guidance applies to national banks and
state chartered banks (institutions). Further, the Board believes that
the Guidance is broadly applicable to bank holding companies.
DATES: Effective Date: The final Guidance is effective December 12,
FOR FURTHER INFORMATION CONTACT:
OCC: Dena G. Patel, Credit Risk Specialist, (202) 874-5170; or
Vance Price, National Bank Examiner, (202) 874-5170.
Board: Denise Dittrich, Supervisory Financial Analyst, (202) 452-
2783; Virginia Gibbs, Senior Supervisory Financial Analyst, (202) 452-
2521; or Sabeth I. Siddique, Assistant Director, (202) 452-3861,
Division of Banking Supervision and Regulation; or Mark Van Der Weide,
Senior Counsel, Legal Division, (202) 452-2263. For users of
Telecommunications Device for the Deaf (``TDD'') only, contact (202)
FDIC: Patricia A. Colohan, Senior Examination Specialist, (202)
898-7283; or Serena L. Owens, Chief, Planning and Program Development,
(202) 898-8996, Division of Supervision and Consumer Protection; or
Benjamin W. McDonough, Attorney, Legal Division, (202) 898-7411.
The Agencies have observed that commercial real estate (CRE)
concentrations have been rising over the past several years and have
reached levels that could create safety and soundness concerns in the
event of a significant economic downturn. To some extent, the level of
CRE lending reflects changes in the demand for credit within certain
geographic areas and the movement by many financial institutions to
specialize in a lending sector that is perceived to offer enhanced
earnings. In particular, small to mid-size institutions have shown the
most significant increase in CRE concentrations over the last decade.
CRE concentration levels \1\ at commercial and savings banks with
assets between $100 million and $1 billion have doubled from
approximately 156 percent of total risk-based capital in 1993 to 318
percent in third quarter 2006. This same trend has been observed at
commercial and savings banks with assets of $1 billion to $10 billion
with concentration levels rising from approximately 127 percent in 1993
to approximately 300 percent in third quarter 2006.
\1\ CRE concentration levels for loans secured by real estate
for (a) construction, land development, and other land loans; (b)
multifamily residential properties; and (c) nonfarm nonresidential
While current CRE market fundamentals remain generally strong, and
supply and demand are generally in balance, past history has
demonstrated that commercial real estate markets can experience fairly
rapid changes. For institutions with significant concentrations, the
ability to withstand difficult market conditions will depend heavily on
the adequacy of their risk management practices and capital levels. In
recent examinations, the Agencies' examiners have observed that some
institutions have relaxed their underwriting standards as a result of
strong competition for business. Further, examiners also have
identified a number of institutions with high CRE concentrations that
lack appropriate policies and procedures to manage the associated risk
arising from a CRE concentration. For these reasons, the Agencies are
concerned with institutions' CRE concentrations and the risks arising
from such concentrations.
To address these concerns, the Agencies published for comment
proposed Interagency Guidance on Concentrations in Commercial Real
Estate Lending, Sound Risk Management Practices, 71 FR 2302 (January
13,2006). The proposal set forth thresholds to identify institutions
with CRE loan concentrations that would be subject to greater
supervisory scrutiny. As provided in the proposal, an institution
exceeding these thresholds would be deemed to have a CRE concentration
and expected to have appropriate risk management practices as described
in the proposed guidance.
After reviewing the public comment letters \2\ on the proposal, the
Agencies are now issuing final Guidance to remind institutions that
there are substantial risks posed by CRE concentrations and that these
risks should be recognized and appropriately addressed. The final
Guidance describes sound risk management practices that are important
for an institution that has strategically decided to concentrate in CRE
lending. These risk management practices build upon existing real
estate lending regulations and guidelines. The Agencies also have
clarified that they are not establishing a limit on the amount of
commercial real estate lending that an institution may conduct.
In addition, the final Guidance includes supervisory criteria to help
the Agencies' supervisory staff identify institutions that may have
significant CRE concentration risk.
\2\ The Agencies did receive a number of comment letters
requesting a 30-day extension of the comment period, which the
Agencies granted. See 71 FR 13215 (March 14, 2006).
II. Proposed Guidance
The proposed guidance described the Agencies' expectations for
heightened risk management practices for an institution with a
concentration in CRE loans. Further, the proposal set forth two
thresholds to identify institutions with CRE loan concentrations that
would be subject to greater supervisory scrutiny. The proposal provided
that such institutions should have in place the heightened risk
management practices and capital levels set forth in the proposal.
The first proposed threshold stated that if loans for construction,
land development, and other land were 100 percent or more of total
capital, the institution would be considered to have a CRE
concentration and should have heightened risk management practices.
Secondly, if loans for construction, land development, and other land
and loans secured by multifamily and nonfarm nonresidential property
(excluding loans secured by owner-occupied properties) were 300 percent
or more of total capital, the institution would also be considered to
have a CRE concentration and should employ heightened risk management
The proposal described the key risk management elements for an
institution's CRE lending activity with an emphasis on those components
of the risk management process that are particularly applicable to an
institution with a CRE concentration, including: board and management
oversight, strategic planning, underwriting, risk assessment and
monitoring of CRE loans, portfolio risk management, management
information systems, market analysis, and stress testing. The proposal
also reminded institutions with CRE concentrations that they should
hold capital exceeding regulatory minimums and commensurate with the
level of risk in their CRE lending portfolios.
III. Overview of Public Comments
Collectively, the Agencies received over 4,400 comment letters on
the proposed guidance. The OCC received approximately 1,700 comment
letters, the Board had approximately 1,700 letters, and the FDIC had
approximately 1,000 letters. The majority of comment letters were from
regulated financial institutions and their trade groups.
Among the trade or other groups submitting comments were seven
nationwide banking trade associations, 26 state banking trade
associations, the Conference of State Bank Supervisors, three state
financial institution regulatory agencies, the Appraisal Institute, the
National Association of Home Builders, National Association of REITs,
and Real Estate Roundtable. Additionally, during the comment period,
the Agencies met with several industry groups.
The vast majority of commenters expressed strong opposition to the
proposed guidance and believe that the Agencies should address the
issue of CRE concentration risk on a case-by-case basis as part of the
examination process. Many commenters contended that existing
regulations and guidance are sufficient to address the Agencies'
concerns regarding CRE concentration risk and the adequacy of an
institution's risk management practices and capital.
Several commenters asserted that today's lending environment is
significantly different than that of the late 1980s and early 1990s
when regulated financial institutions suffered losses from their real
estate lending activities due to weak underwriting standards and risk
management practices. These commenters contended that regulated
financial institutions learned their lessons from past economic cycles
and that underwriting practices are now stronger.
Many community-based institutions, particularly Florida-based and
Massachusetts-based institutions, opposed the proposed guidance and
contended that the proposal would discourage community-based
institutions from CRE lending and serving the needs of their
communities. If community-based institutions were forced to reduce
their CRE lending activity, these commenters asserted that there was
the potential for a downturn in the economy, creating systemic problems
beyond the risks in CRE loans.
While smaller institutions acknowledged that many community banks
do concentrate in commercial real estate loans, they contended that
there are few other lending opportunities in which community-based
institutions can successfully compete against larger financial
institutions. Community-based institutions commented that secured real
estate lending has been their ``bread and butter'' business and, if
required to reduce their commercial real estate lending activity, they
would have to look to other types of lending, which have been
historically more risky. Moreover, these commenters noted that
community-based institutions are actively involved in their local
communities and markets, which affords them a significant advantage
when competing for CRE loan business. Community-based institutions also
noted that their lending opportunities have dwindled as a result of
competition from other types of financial institutions, such as finance
companies, Farm Credit banks, and credit unions.
IV. Overview of Final Guidance
After carefully reviewing the comments on the proposed guidance,
the Agencies have made significant changes to the proposal to clarify
the purpose and scope of the Guidance. The Agencies continue to believe
that it is important for institutions with CRE credit concentrations to
assess the risk posed by the concentration and to maintain sound risk
management practices and an adequate level of capital to address the
risk. Therefore, while the final Guidance continues to emphasize these
principles, the Agencies have revised the proposal to clarify that
financial institutions play a vital role in providing credit for
commercial real estate activity and to make clear that the Guidance
does not establish a limit on an institution's CRE lending activity.
A discussion of the changes in the final Guidance from the
proposal, major comments on the proposal, and the Agencies' responses
The final Guidance reminds institutions that sound risk management
practices and appropriate capital levels are important when an
institution has a CRE concentration. Like the proposal, the final
Guidance reinforces and builds upon the Agencies' existing regulations
and guidelines for real estate lending and loan portfolio management.
Commenters expressed concern that the proposal placed additional
burden on institutions that already have sound practices in place to
manage their CRE lending activity. Further, commenters contended that
the Agencies have sufficient existing authority to address their
concerns with an institution's CRE lending activity and that the
Agencies' examination process affords the Agencies with ample
opportunity to address weaknesses in an institution's lending
The Agencies are issuing the final Guidance to remind institutions
of the substantial potential risks posed by credit concentrations,
especially in sectors such as CRE, which history has shown to have
cycles that can, at much lower concentration levels, inflict large
losses upon institutions. While most institutions are practicing sound
risk management on a transaction basis, the Agencies believe this
Guidance is necessary to emphasize the importance of portfolio risk
management practices to address CRE concentration risk.
The final Guidance, like the proposal, focuses on CRE loans that
have risk profiles sensitive to the condition of the general CRE
market. This includes loans for land development and construction
(including 1- to 4-family residential and commercial properties), other
land loans, and loans secured by multifamily and nonfarm nonresidential
properties (where the primary source of repayment is cash flows from
the real estate collateral). Loans to REITs and unsecured loans to
developers also are considered CRE loans for purposes of this Guidance
if their performance is closely linked to the performance of the
general CRE market.
Commenters noted that the identification of CRE loans in the
current Consolidated Reports of Condition and Income (Call Report) did
not correspond to the proposed guidance's CRE definition and did not
constitute an accurate measurement of the volume of an institution's
CRE loans that would be vulnerable to cyclical CRE markets. Commenters
did acknowledge that the revisions to the Call Reports, effective in
2007, would address this inconsistency.
In response to these comments, the Agencies have clarified that the
focus of the Guidance is on those CRE loans where the cash flow from
the real estate collateral is the primary source of repayment rather
than on loans to a borrower where real estate is a secondary source of
repayment or is taken as collateral through an abundance of caution.
This is consistent with the 2007 revisions to the Call Report.
Many commenters found the proposal's definition of CRE loans overly
broad and failed to recognize unique risks posed by loans with
different risk characteristics. Further, commenters asked for
clarification as to the types of properties included in the scope of
the Guidance, such as loans secured by motels, hotels, mini-storage
warehouse facilities, and apartment complexes where the primary source
of repayment is rental or lease income. A number of commenters
contended that loans on certain types of CRE properties should not be
considered CRE loans, including: Presold 1- to 4-family residential
construction loans, multifamily loans, and loans to REITs.
Commenters recommended that the proposal should not cover
residential construction loans where a house has been sold to a
qualified borrower prior to the start of the construction. These
commenters argued that presold 1- to 4-family residential construction
loans carry far less risk than speculative home construction loans
because the future homeowners are known and contractually obligated to
purchase the home, and have passed a credit review prior to the
commencement of construction. Commenters noted that their rationale for
excluding presold 1- to 4-family residential construction is consistent
with the proposal's exclusion of CRE loans on owner-occupied
Further, commenters recommended that multifamily construction loans
with firm takeouts or loans on completed multifamily properties with
established rent rolls be excluded from the scope of the guidance.
Commenters contended that multifamily residential loans have much less
risk than CRE loans that have no firm takeout or established cash flow
history.\3\ One commenter noted that over the last 20 years,
institutions have incurred minimal losses on multifamily loans and
attributed this performance to strong underwriting and stability in
\3\ Another commenter, representing REITs, sought clarification
as to whether the proposed guidance would apply to both secured and
unsecured loans to REITs. This commenter asserted that unsecured
loans to REITs should not be considered a CRE loan for purposes of
the proposed guidance as the commenter believes that the risk of an
unsecured loan to a REIT is mitigated by well-diversified cash flow
comprising the sources of repayment. The final Guidance, like the
proposal, applies to both secured and unsecured loans to REITs where
repayment capacity is sensitive to conditions of the general CRE
market. The Agencies note that the structure of such loans would be
considered a mitigating factor when an institution analyzes the risk
posed by such a concentration.
The Agencies note that because the Guidance does not impose lending
limits, its scope is purposely broad so that it includes those CRE
loans, including multifamily loans, with risk profiles sensitive to the
condition of the general CRE markets, such as market demand, changes in
capitalization rates, vacancy rates, and rents. However, the Agencies
believe that institutions are in the best position to segment their CRE
portfolios and group credit exposures by common risk characteristics or
sensitivities to economic, financial, or business developments. As
explained in the final Guidance, institutions should be able to
identify potential concentrations in their CRE portfolios by common
risk characteristics, which will differ by property type. The final
Guidance notes that factors, such as portfolio diversification,
geographic dispersion, levels of underwriting standards, level of
presold buildings, and portfolio liquidity, would be considered in
evaluating whether an institution has mitigated the risk posed by a
concentration. Further, the Agencies acknowledge in the final guidance
that consideration should be given to the lower risk profiles and
historically superior performance of certain types of CRE such as well-
structured multifamily housing loans, when compared to others, such as
speculative office construction.
C. CRE Concentration Assessment
The final Guidance contains a new section referred to as ``CRE
Concentration Assessment'' that provides that institutions should
perform their own assessment of concentration risk in their CRE loan
portfolios. While the final Guidance does not establish a CRE
concentration limit, the Agencies have retained high-level indicators
to assist examiners in identifying institutions potentially exposed to
CRE concentration risk. These are described in section IV.E of this
Many commenters noted that the proposal did not recognize the
different segments in an institution's CRE portfolio and treated all
CRE loans as having equal risk. A commenter noted that a concentration
test cannot reflect the distinct risk profile within an institution's
loan portfolio and that the risk profile is a function of many factors,
including the institution's risk tolerance, portfolio diversification,
the prevalence of guarantees and secondary collateral, and the
condition of the regional economy.
In response to such comments, the Agencies have added a section on
CRE Concentration Assessments to the final Guidance. The Agencies
recognize that risk characteristics vary by different property types of
CRE loans and that institutions are in the best position to identify
potential concentrations by stratifying their CRE portfolios into
segments with common risk characteristics. The Agencies believe an
institution's board of directors and management should identify and
monitor credit concentrations and establish internal concentration
limits. The final Guidance clarifies that an institution actively
involved in CRE lending should be able to identify concentrations in
its CRE portfolio and to monitor concentration risk on an ongoing
Commenters raised concern that the proposed thresholds would be
perceived by examiners as de facto limits on an institution's CRE
lending activity. The Agencies believe that the
final Guidance addresses the concerns of commenters by placing the
emphasis on the institution's own assessment of its CRE concentration
risk rather than on the proposed concentration thresholds. In the final
Guidance, the Agencies have responded to these concerns by specifically
stating that the Guidance does not establish any specific limits on
institutions' CRE lending activity. Moreover, in implementing the
Guidance, the Agencies will take the necessary steps to communicate the
purpose of the Guidance to their supervisory staffs to prevent any
The final Guidance does incorporate the proposed concentration
thresholds as part of the Agencies' supervisory oversight criteria for
examiners to use as a starting point for identifying institutions that
are potentially exposed to significant CRE concentration risk. The
Agencies believe that these numerical supervisory screens will serve to
promote consistent application of this Guidance across the Agencies as
well as within an agency. The supervisory oversight and evaluation of
an institution's CRE concentration risk are discussed in more detail in
section IV.E. of the preamble.
D. Risk Management
The final Guidance, like the proposal, builds upon the Agencies'
existing regulations and guidance for real estate lending and loan
portfolio management, emphasizing those risk management practices that
will enable an institution to pursue CRE lending in a safe and sound
Many commenters acknowledged that the risk management principles
described in the proposal should be viewed as prudent industry
standards for an institution engaged in CRE lending. However, some
commenters alleged that the proposed guidance would create additional
regulatory burden at a time when institutions are already faced with
other compliance responsibilities. Further, commenters noted that the
Agencies needed to consider an institution's size and complexity in
assessing the adequacy of risk management practices. This particular
concern was raised with regard to the expectations for management
information systems and portfolio stress testing that commenters found
to be burdensome for smaller institutions.
In response to these comments, the Agencies have revised the final
Guidance's risk management section to make the discussion more
principle-based and to focus on those aspects of existing regulations
and guidelines that deserve greater attention when an institution has a
CRE concentration or is pursuing a CRE lending strategy leading to a
concentration. As a result, the risk management section in the final
Guidance sets forth the key elements of an institution's risk
management framework for managing concentration risk. Further, the
final Guidance recognizes the sophistication of an institution's risk
management processes will depend upon the size of the CRE portfolio and
the level and nature of its CRE concentration risk.
The final Guidance describes the key elements that an institution
should address in board and management oversight, portfolio management,
management information systems, market analysis, credit underwriting
standards, portfolio stress testing and sensitivity analysis, and
credit risk review function. In general, an institution with a CRE
concentration should manage not only the risk of the individual loans
but also the portfolio risk. Recognizing that an institution's board of
directors has ultimate responsibility for the level of risk assumed by
the institution, the Agencies believe that appropriate board oversight
should address the rationale for an institution's CRE lending levels in
relation to its growth objectives, financial targets, and capital plan.
The Agencies believe that the final Guidance's discussion of
management information systems (MIS), market analysis, and portfolio
stress testing addresses the concerns of smaller institutions regarding
regulatory burden. The Agencies recognize that the level of
sophistication of an institution's MIS, market analysis and stress
testing will depend upon the size and complexity of the institution.
Therefore, the focus of the final Guidance is on the ability of the
institution to provide its management and board of directors with the
necessary information to assess its CRE lending strategy and policies
in light of changes in CRE market conditions. Regardless of its size,
an institution should be able to identify and monitor CRE
concentrations and the potential effect that changes in market
conditions may have on the institution.
Some commenters requested clarification on the Agencies'
expectations for stress testing. These commenters expressed concern
that, as a result of the proposal, management's time would be diverted
to creating reports and statistics with not much value. These
commenters represented that an institution's focus should be on a loan
review program, portfolio monitoring procedures, and loan loss
The Agencies agree with these comments and have revised the
discussion on market analysis and stress testing. The final Guidance
acknowledges that an institution's market analysis will vary by its
market share and exposure levels as well as the availability of market
data. Further, the final Guidance notes that portfolio stress testing
does not require the use of sophisticated portfolio models. Depending
on the institution, stress testing may be as simple as analyzing the
potential effect of stressed loss rates on the institution's CRE
portfolio, capital, and earnings. The important objective is that an
institution should have the information necessary to assess the
potential effect of market changes on its CRE portfolio and lending
Commenters questioned the proposed guidance's suggestion that
institutions should compare their underwriting standards to those of
the secondary commercial mortgage market. Commenters noted that there
is not a ready secondary market for CRE loans made by smaller
institutions as the loans are smaller in dollar size and have
characteristics that make them unsuitable for securitization.
The Agencies recognize that smaller institutions do not have ready
access to the secondary market and had not intended that the proposal
be viewed in this way. Therefore, in the final Guidance, the Agencies
have clarified the situations when an institution should conduct
secondary market comparisons. If an institution's portfolio management
strategy includes selling or securitizing CRE loans as a contingency
plan for managing concentration levels, an institution should evaluate
its ability to do so and compare its underwriting standards to those of
the secondary market.
E. Supervisory Oversight
In the final Guidance, the Agencies have retained the concept of
concentration thresholds as a supervisory tool for examiners to screen
institutions for potential CRE concentration risk. The intent of these
indicators is to encourage a dialogue between the Agency supervisory
staff and an institution's management about the level and nature of CRE
concentration risk. While the final Guidance is effective immediately
upon publication in the Federal Register, the Agencies will provide
institutions with CRE concentrations a reasonable timeframe over which
to demonstrate that their risk management practices are appropriate for
the level and nature of the concentration risk.
Commenters encouraged the Agencies to evaluate institutions' CRE
concentrations on a bank-by-bank basis and not to take a ``one-size-
fits-all'' approach to evaluating concentrations. Commenters asserted
that an assessment of concentration risk based on the Agencies'
proposed thresholds did not consider the differing risk characteristics
of the subcategories of CRE loans. Further, commenters noted that the
proposed thresholds did not consider whether or not an institution had
an established history of managing a high CRE concentration.
In the final Guidance, the Agencies addressed the commenters'
concerns by stating that numeric indicators do not constitute limits;
rather they will be used as a supervisory monitoring tool. These
indicators will assist examiners in identifying institutions with CRE
concentrations. These indicators will function similarly to other
analytical screens that the Agencies use to evaluate an institution. By
including these indicators in the final Guidance, institutions will
have an understanding of the Agencies' supervisory monitoring criteria.
The Agencies also have tried to strike a balanced tone in the final
Guidance to promote an appropriate and consistent application of these
indicators by their supervisory staffs.
As explained in the final Guidance, an institution that has
experienced rapid growth in CRE lending, has notable exposure to a
specific type of CRE, or is approaching or exceeds the following
supervisory criteria may be identified for further supervisory analysis
of the level and nature of its CRE concentration risk. The supervisory
(1) Total reported loans for construction, land development, and
other land \4\ represent 100 percent or more of the institution's total
capital; \5\ or
\4\ For commercial banks, this total is reported in the Call
Report FFIEC 031 and 041 schedule RC-C item 1a.
\5\ For purposes of this Guidance, the term ``total capital''
means the total risk-based capital as reported for commercial banks
in the Call Report FFIEC 031 and 041 schedule RC-R--Regulatory
Capital, line 21.
(2) Total commercial real estate loans as defined in the Guidance
\6\ represent 300 percent or more of the institution's total capital
and the outstanding balance of the institution's CRE loan portfolio has
increased 50 percent or more during the prior 36 months.
\6\ For commercial banks, this total is reported in the Call
Report FFIEC 031 and 041 schedule RC-C items 1a, 1d, 1e, and
Memorandum Item 3.
While the criteria will serve as a screen for identifying
institutions with potential CRE concentration risk, the final Guidance
notes that institutions should not view the criteria as a ``safe
harbor'' if other risk indicators are present, regardless of the
measurements under criteria (1) and (2). Further, the final Guidance
notes that institutions experiencing recent, significant growth in CRE
lending will receive closer supervisory review than other institutions
that have demonstrated a successful track record of managing the risks
in CRE concentrations.
In response to comments that the proposal concentration thresholds
did not consider an institution's track record for managing CRE
concentrations, the Agencies have included an additional condition to
the 300 percent screen. The Agencies also will consider whether the
institution's CRE portfolio increased by 50 percent or more during the
prior 36 months. This additional screen acknowledges that the Agencies
will be focusing on those institutions that have recently experienced a
significant growth in their CRE portfolio and may not have been subject
to prior supervisory review.
While most commenters opposed the adoption of any concentration
thresholds, several commenters did comment on the appropriateness of
the proposed CRE concentration thresholds. These commenters asserted
that the proposed 300 percent threshold was too low and suggested that
a benchmark from 400 to 600 percent of capital would be more
As previously discussed, the Agencies have retained the 300 percent
screen with an additional screen (that is, an institution's CRE
portfolio increased by 50 percent or more during the prior 36 months).
In developing the supervisory criteria, the Agencies relied on
historical trends in concentration levels over real estate cycles, the
relationship of CRE concentration levels to bank failures, and
supervisory experience. Further, the final Guidance clarifies that the
Agencies' supervisory staffs will consider other factors, and not just
these indicators, in evaluating the risk posed by an institution's CRE
F. Assessment of Capital Adequacy
In the final Guidance, the section on the ``Assessment of Capital
Adequacy'' was significantly revised to address the commenters'
concerns that the proposal was too restrictive and did not take into
account the institution's lending and risk management practices. The
proposal stated that institutions should hold capital commensurate with
the level and nature of their CRE concentration risks and that an
institution with high or inordinate levels of risk would be expected to
operate well above minimum regulatory capital requirements. In the
final Guidance, the discussion on the adequacy of an institution's
capital has been incorporated into the Supervisory Oversight section to
clarify that the assessment of an institution's capital will be
performed in connection with the supervisory assessment of an
institution's risk management.
Commenters asserted that many institutions already hold capital at
levels above minimum standards and should not be required to raise
additional capital simply because their CRE concentrations exceeded a
threshold. There also was concern that the proposal would give
examiners the ability to arbitrarily assess additional capital
requirements solely due to a high concentration.
The Agencies agree with commenters that the majority of
institutions with CRE concentrations presently have capital exceeding
regulatory minimums and would generally not be expected to increase
their capital levels. However, since an institution's capital serves as
a buffer against unexpected losses from its CRE concentration, an
institution with a CRE concentration and inadequate capital should
develop a plan for reducing its concentration or maintaining capital
appropriate for the level and nature of the concentration risk. To the
extent an institution with a CRE concentration has effective risk
management practices or is addressing the need for such practices, the
Agencies' concerns regarding capital adequacy are reduced. However, an
institution with a CRE concentration and with no prospects of enhancing
its risk management practices should address the need for additional
capital. Therefore, the final Guidance reminds institutions that they
should hold capital commensurate with the level and nature of the risks
to which they are exposed.
Commenters noted that the allowance for loan and lease losses
(ALLL) is another means of protection for an institution and,
therefore, should be considered in determining whether capital is
adequate for the level and nature of concentration risk. The Agencies
agree with this comment and have addressed ALLL within the context of
the capital adequacy section.
V. Text of the Final Joint Guidance
The text of the final joint Guidance on Concentrations in
Commercial Real Estate Lending, Sound Risk Management Practices
Concentrations in Commercial Real Estate Lending, Sound Risk Management
The Office of the Comptroller of the Currency, the Board of
Governors of the Federal Reserve System, and the Federal Deposit
Insurance Corporation (collectively, the Agencies), are jointly issuing
this Guidance to address institutions' increased concentrations of
commercial real estate (CRE) loans. Concentrations of credit exposures
add a dimension of risk that compounds the risk inherent in individual
The Guidance reminds institutions that strong risk management
practices and appropriate levels of capital are important elements of a
sound CRE lending program, particularly when an institution has a
concentration in CRE loans. The Guidance reinforces and enhances the
Agencies' existing regulations and guidelines for real estate lending
\1\ and loan portfolio management in light of material changes in
institutions' lending activities. The Guidance does not establish
specific CRE lending limits; rather, it promotes sound risk management
practices and appropriate levels of capital that will enable
institutions to continue to pursue CRE lending in a safe and sound
\1\ Refer to the Agencies' regualtions on real estate lending
standards and the Interagency Guidelines for Real Estate Lending
Policies: 12 CFR part 34, subpart D and appendix A (OCC); 12 CFR
part 208, subpart E and appendix C (FRB); and 12 CFR part 365 and
appendix A (FDIC). Refer to the Interagency Guidelines Establishing
Standards for Safety and Soundness: 12 CFR part 30, appendix A
(OCC); 12 CFR part 208, Appendix D-1 (FRB); and 12 CFR part 364,
appendix A (FDIC).
The Agencies recognize that regulated financial institutions play a
vital role in providing credit for business and real estate
development. However, concentrations in CRE lending coupled with weak
loan underwriting and depressed CRE markets have contributed to
significant credit losses in the past. While underwriting standards are
generally stronger than during previous CRE cycles, the Agencies have
observed an increasing trend in the number of institutions with
concentrations in CRE loans. These concentrations may make such
institutions more vulnerable to cyclical CRE markets. Moreover, the
Agencies have observed that some institutions' risk management
practices are not evolving with their increasing CRE concentrations.
Therefore, institutions with concentrations in CRE loans are reminded
that their risk management practices and capital levels should be
commensurate with the level and nature of their CRE concentration risk.
In developing this guidance, the Agencies recognized that different
types of CRE lending present different levels of risk, and that
consideration should be given to the lower risk profiles and
historically superior performance of certain types of CRE, such as
well-structured multifamily housing finance, when compared to others,
such as speculative office space construction. As discussed under ``CRE
Concentration Assessments,'' institutions are encouraged to segment
their CRE portfolios to acknowledge these distinctions for risk
This Guidance focuses on those CRE loans for which the cash flow
from the real estate is the primary source of repayment rather than
loans to a borrower for which real estate collateral is taken as a
secondary source of repayment or through an abundance of caution. Thus,
for the purposes of this Guidance, CRE loans include those loans with
risk profiles sensitive to the condition of the general CRE market (for
example, market demand, changes in capitalization rates, vacancy rates,
or rents). CRE loans are land development and construction loans
(including 1 - to 4-family residential and commercial construction
loans) and other land loans.
CRE loans also include loans secured by multifamily property, and
nonfarm nonresidential property where the primary source of repayment
is derived from rental income associated with the property (that is,
loans for which 50 percent or more of the source of repayment comes
from third party, nonaffiliated, rental income) or the proceeds of the
sale, refinancing, or permanent financing of the property. Loans to
real estate investment trusts (REITs) and unsecured loans to developers
also should be considered CRE loans for purposes of this Guidance if
their performance is closely linked to performance of the CRE markets.
Excluded from the scope of this Guidance are loans secured by nonfarm
nonresidential properties where the primary source of repayment is the
cash flow from the ongoing operations and activities conducted by the
party, or affiliate of the party, who owns the property.
Although the Guidance does not define a CRE concentration, the
``Supervisory Oversight'' section describes the criteria that the
Agencies will use as high-level indicators to identify institutions
potentially exposed to CRE concentration risk.
CRE Concentration Assessments
Institutions actively involved in CRE lending should perform
ongoing risk assessments to identify CRE concentrations. The risk
assessment should identify potential concentrations by stratifying the
CRE portfolio into segments that have common risk characteristics or
sensitivities to economic, financial or business developments. An
institution's CRE portfolio stratification should be reasonable and
supportable. The CRE portfolio should not be divided into multiple
segments simply to avoid the appearance of concentration risk.
The Agencies recognize that risk characteristics vary among CRE
loans secured by different property types. A manageable level of CRE
concentration risk will vary by institution depending on the portfolio
risk characteristics, the quality of risk management processes, and
capital levels. Therefore, the Guidance does not establish a CRE
concentration limit that applies to all institutions. Rather, the
Guidance encourages institutions to identify and monitor credit
concentrations, establish internal concentration limits, and report all
concentrations to management and the board of directors on a periodic
basis. Depending on the results of the risk assessment, the institution
may need to enhance its risk management systems.
The sophistication of an institution's CRE risk management
processes should be appropriate to the size of the portfolio, as well
as the level and nature of concentrations and the associated risk to
the institution. Institutions should address the following key elements
in establishing a risk management framework that effectively
identifies, monitors, and controls CRE concentration risk:
Board and management oversight.
Management information systems.
Credit underwriting standards.
Portfolio stress testing and sensitivity analysis.
Credit risk review function.
Board and Management Oversight. An institution's board of directors
has ultimate responsibility for the level of risk assumed by the
institution. If the institution has significant CRE concentration risk,
its strategic plan should address the rationale for its CRE levels in
relation to its overall growth objectives, financial targets, and
plan. In addition, the Agencies' real estate lending regulations
require that each institution adopt and maintain a written policy that
establishes appropriate limits and standards for all extensions of
credit that are secured by liens on or interests in real estate,
including CRE loans. Therefore, the board of directors or a designated
committee thereof should:
Establish policy guidelines and approve an overall CRE
lending strategy regarding the level and nature of CRE exposures
acceptable to the institution, including any specific commitments to
particular borrowers or property types, such as multifamily housing.
Ensure that management implements procedures and controls
to effectively adhere to and monitor compliance with the institution's
lending policies and strategies.
Review information that identifies and quantifies the
nature and level of risk presented by CRE concentrations, including
reports that describe changes in CRE market conditions in which the
Periodically review and approve CRE risk exposure limits
and appropriate sublimits (for example, by nature of concentration) to
conform to any changes in the institution's strategies and to respond
to changes in market conditions.
Portfolio Management. Institutions with CRE concentrations should
manage not only the risk of individual loans but also portfolio risk.
Even when individual CRE loans are prudently underwritten,
concentrations of loans that are similarly affected by cyclical changes
in the CRE market can expose an institution to an unacceptable level of
risk if not properly managed. Management regularly should evaluate the
degree of correlation between related real estate sectors and establish
internal lending guidelines and concentration limits that control the
institution's overall risk exposure.
Management should develop appropriate strategies for managing CRE
concentration levels, including a contingency plan to reduce or
mitigate concentrations in the event of adverse CRE market conditions.
Loan participations, whole loan sales, and securitizations are a few
examples of strategies for actively managing concentration levels
without curtailing new originations. If the contingency plan includes
selling or securitizing CRE loans, management should assess
periodically the marketability of the portfolio. This should include an
evaluation of the institution's ability to access the secondary market
and a comparison of its underwriting standards with those that exist in
the secondary market.
Management Information Systems. A strong management information
system (MIS) is key to effective portfolio management. The
sophistication of MIS will necessarily vary with the size and
complexity of the CRE portfolio and level and nature of concentration
risk. MIS should provide management with sufficient information to
identify, measure, monitor, and manage CRE concentration risk. This
includes meaningful information on CRE portfolio characteristics that
is relevant to the institution's lending strategy, underwriting
standards, and risk tolerances. An institution should assess
periodically the adequacy of MIS in light of growth in CRE loans and
changes in the CRE portfolio's size, risk profile, and complexity.
Institutions are encouraged to stratify the CRE portfolio by
property type, geographic market, tenant concentrations, tenant
industries, developer concentrations, and risk rating. Other useful
stratifications may include loan structure (for example, fixed rate or
adjustable), loan purpose (for example, construction, short-term, or
permanent), loan-to-value limits, debt service coverage, policy
exceptions on newly underwritten credit facilities, and affiliated
loans (for example, loans to tenants). An institution should also be
able to identify and aggregate exposures to a borrower, including its
credit exposure relating to derivatives.
Management reporting should be timely and in a format that clearly
indicates changes in the portfolio's risk profile, including risk-
rating migrations. In addition, management reporting should include a
well-defined process through which management reviews and evaluates
concentration and risk management reports, as well as special ad hoc
analyses in response to potential market events that could affect the
CRE loan portfolio.
Market Analysis. Market analysis should provide the institution's
management and board of directors with information to assess whether
its CRE lending strategy and policies continue to be appropriate in
light of changes in CRE market conditions. An institution should
perform periodic market analyses for the various property types and
geographic markets represented in its portfolio.
Market analysis is particularly important as an institution
considers decisions about entering new markets, pursuing new lending
activities, or expanding in existing markets. Market information also
may be useful for developing sensitivity analysis or stress tests to
assess portfolio risk.
Sources of market information may include published research data,
real estate appraisers and agents, information maintained by the
property taxing authority, local contractors, builders, investors, and
community development groups. The sophistication of an institution's
analysis will vary by its market share and exposure, as well as the
availability of market data. While an institution operating in
nonmetropolitan markets may have access to fewer sources of detailed
market data than an institution operating in large, metropolitan
markets, an institution should be able to demonstrate that it has an
understanding of the economic and business factors influencing its
Credit Underwriting Standards. An institution's lending policies
should reflect the level of risk that is acceptable to its board of
directors and should provide clear and measurable underwriting
standards that enable the institution's lending staff to evaluate all
relevant credit factors. When an institution has a CRE concentration,
the establishment of sound lending policies becomes even more critical.
In establishing its policies, an institution should consider both
internal and external factors, such as its market position, historical
experience, present and prospective trade area, probable future loan
and funding trends, staff capabilities, and technology resources.
Consistent with the Agencies' real estate lending guidelines, CRE
lending policies should address the following underwriting standards:
Maximum loan amount by type of property.
Loan-to-Value (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.
\2\ Refer to the Agencies' appraisal regualtins: 12 CFR part 34,
subpart C (OCC); 12 CFR part 208 subpart E and 12 CFR part 225,
subpart G (FRB); and 12 CFR part 323 (FDIC).
Minimum standards for borrower net worth, property cash
flow, and debt service coverage for the property.
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 or designated
committee detailing the number, nature, justifications, and trends for
exceptions. Exceptions to both the institution's internal lending
standards and the Agencies' supervisory LTV limits \3\ should be
monitored and reported on a regular basis. Further, institutions should
analyze trends in exceptions to ensure that risk remains within the
institution's established risk tolerance limits.
\3\ The Interagency Guidelines for Real Estate Lending state
that loans exceeding the supervisory LTV guidelines should be
recorded in the institution's records and reported to the board at
Credit analysis should reflect both the borrower's overall
creditworthiness and project-specific considerations as appropriate. In
addition, for development and construction loans, the institution
should have policies and procedures governing loan disbursements to
ensure that the institution's minimum borrower equity requirements are
maintained throughout the development and construction periods. Prudent
controls should include an inspection process, documentation on
construction progress, tracking pre-sold units, pre-leasing activity,
and exception monitoring and reporting.
Portfolio Stress Testing and Sensitivity Analysis. An institution
with CRE concentrations should perform portfolio-level stress tests or
sensitivity analysis to quantify the impact of changing economic
conditions on asset quality, earnings, and capital. Further, an
institution should consider the sensitivity of portfolio segments with
common risk characteristics to potential market conditions. The
sophistication of stress testing practices and sensitivity analysis
should be consistent with the size, complexity, and risk
characteristics of its CRE loan portfolio. For example, well-margined
and seasoned performing loans on multifamily housing normally would
require significantly less robust stress testing than most acquisition,
development, and construction loans.
Portfolio stress testing and sensitivity analysis may not
necessarily require the use of a sophisticated portfolio model.
Depending on the risk characteristics of the CRE portfolio, stress
testing may be as simple as analyzing the potential effect of stressed
loss rates on the CRE portfolio, capital, and earnings. The analysis
should focus on the more vulnerable segments of an institution's CRE
portfolio, taking into consideration the prevailing market environment
and the institution's business strategy.
Credit Risk Review Function. A strong credit risk review function
is critical for an institution's self-assessment of emerging risks. An
effective, accurate, and timely risk-rating system provides a
foundation for the institution's credit risk review function to assess
credit quality and, ultimately, to identify problem loans. Risk ratings
should be risk sensitive, objective, and appropriate for the types of
CRE loans underwritten by the institution. Further, risk ratings should
be reviewed regularly for appropriateness.
As part of their ongoing supervisory monitoring processes, the
Agencies will use certain criteria to identify institutions that are
potentially exposed to significant CRE concentration risk. An
institution that has experienced rapid growth in CRE lending, has
notable exposure to a specific type of CRE, or is approaching or
exceeds the following supervisory criteria may be identified for
further supervisory analysis of the level and nature of its CRE
(2) Total commercial real estate loans as defined in this Guidance
\6\ represent 300 percent or more of the institution's total capital,
and the outstanding balance of the institution's commercial real estate
loan portfolio has increased by 50 percent or more during the prior 36
\4\ For commercial banks as reported in the Call Report FFIEC
031 and 041, schdule RC-C, item la.
means the total risk-based capital as reported fro commercial banks
\6\ For commercial banks as reported in the Call Report FFIEC
031 and 041 schedule RC-C, items 1a, 1d, 1e, and Memorandum Item
The Agencies will use the criteria as a preliminary step to
identify institutions that may have CRE concentration risk. Because
regulatory reports capture a broad range of CRE loans with varying risk
characteristics, the supervisory monitoring criteria do not constitute
limits on an institution's lending activity but rather serve as high-
level indicators to identify institutions potentially exposed to CRE
concentration risk. Nor do the criteria constitute a ``safe harbor''
for institutions if other risk indicators are present, regardless of
their measurements under (1) and (2).
Evaluation of CRE Concentrations. The effectiveness of an
institution's risk management practices will be a key component of the
supervisory evaluation of the institution's CRE concentrations.
Examiners will engage in a dialogue with the institution's management
to assess CRE exposure levels and risk management practices.
Institutions that have experienced recent, significant growth in CRE
lending will receive closer supervisory review than those that have
demonstrated a successful track record of managing the risks in CRE
In evaluating CRE concentrations, the Agencies will consider the
institution's own analysis of its CRE portfolio, including
consideration of factors such as:
Portfolio diversification across property types.
Geographic dispersion of CRE loans.
Level of pre-sold units or other types of take-out
commitments on construction loans.
Portfolio liquidity (ability to sell or securitize
exposures on the secondary market).
While consideration of these factors should not change the method
of identifying a credit concentration, these factors may mitigate the
risk posed by the concentration.
Assessment of Capital Adequacy. The Agencies' existing capital
adequacy guidelines note that an institution should hold capital
commensurate with the level and nature of the risks to which it is
exposed. Accordingly, institutions with CRE concentrations are reminded
that their capital levels should be commensurate with the risk profile
of their CRE portfolios. In assessing the adequacy of an institution's
capital, the Agencies will consider the level and nature of inherent
risk in the CRE portfolio as well as management expertise, historical
performance, underwriting standards, risk management practices, market
conditions, and any loan loss reserves allocated for CRE concentration
risk. An institution with inadequate capital to serve as a buffer
against unexpected losses from a CRE concentration should develop a
plan for reducing its CRE concentrations or for maintaining capital
appropriate to the level and nature of its CRE concentration risk.
Dated: December 5, 2006.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, December 6, 2006.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, DC, this 6th day of December 2006.
By order of the Federal Deposit Insurance Corporation.
Robert E. Feldman,
[FR Doc. 06-9630 Filed 12-11-06; 8:45 am]
BILLING CODE 4810-33-P