FDIC issues guidance for managing commercial real estate risk

Citing concerns about recent trends in commercial real estate, the FDIC today issued guidance to “reemphasize” the importance of strong capital and robust credit risk-management practices for financial institutions with CRE concentrations. The document replaces similar guidance issued by the agency in 2008.

In the guidance, the FDIC said that the CRE market and lending conditions have been “significantly influenced” by governmental and societal responses to the COVID-19 pandemic, rapidly rising interest rates and the prolonged inverted yield curve. At the same time, CRE investment property capitalization rates have not kept pace with recent rapid increases in long-term interest rates, “which leads to concerns about general over-valuation of underlying collateral,” the agency said.

“Refinancing office and multi-family loans could be challenging in an environment of pressured rent growth, higher interest rates and lower property values, particularly for those institutions with CRE concentrations in areas with surplus office and multi-family space,” the FDIC said. “The FDIC’s concern also extends to the subset of banks with elevated (construction and development) concentrations, which subset has risen in recent quarters, but remains well below the 2007 peak. Banks with significant exposure to C&D loans had substantial credit losses during the 2008-2013 banking crisis, and banks currently engaged in C&D lending could be affected by weaknesses in the current economic environment and real estate fundamentals.”

The guidance lists six risk management actions for financial institutions with significant CRE concentrations: Maintain strong capital levels, ensure that credit loss allowances are appropriate, manage C&D and CRE loan portfolios closely, maintain updated financial and analytical information, bolster loan workout infrastructure, and maintain adequate liquidity and diverse funding sources. The agency added that institutions are encouraged to continue making CRE credit available in their communities “using prudent lending standards that rely on strong underwriting and loan administration practices.”