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An Analysis of the Impact of the Commercial Real Estate Concentration Guidance

Part 1: Executive Summary

This paper analyzes aspects of the interagency guidance issued in 2006, titled "Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices."1 The recent financial crisis and recession provide an opportunity to consider the relationship between the guidance and banks' commercial real estate (CRE) concentrations and performance during the downturn. This paper also analyzes how the share of banking institutions with high levels of CRE concentration, as defined in the guidance, has changed over time (part 2); documents the effect of CRE concentrations on bank failures (part 3); and studies CRE loan growth and bank capital strength since the 2006 issuance of the guidance (part 4).2

The 2006 interagency guidance focuses on the risks of high levels of concentration in CRE lending at banking institutions, and specifically addresses two supervisory criteria:

  • Construction concentration criterion: Loans for construction, land, and land development (CLD or "construction") represent 100 percent or more of a banking institution's total risk-based capital
  • Total CRE concentration criterion: Total non-owner-occupied CRE loans (including CLD loans), as defined in the 2006 guidance ("total CRE"), represent 300 percent or more of the institution's total risk-based capital, and growth in total CRE lending has increased by 50 percent or more during the previous 36 months

The guidance states that banking institutions exceeding the concentration levels mentioned in the two supervisory criteria should have in place enhanced credit risk controls, including stress testing of CRE portfolios.3 The guidance also states that institutions with CRE concentration levels above those specified in the two supervisory criteria may be identified for further supervisory analysis.

It should be noted that the supervisory criteria were not intended to establish hard limits or caps on banking institutions' CRE concentration levels. The 2006 guidance states that "numeric indicators do not constitute limits."4 Therefore, banks with acceptable risk-management practices could retain their high CRE concentration levels. Additionally, the Total CRE criterion applied to institutions contains two joint conditions: (1) Total CRE above a certain level of capital and (2) rapid growth in Total CRE in the previous three years. Jointly applying both measures in the total CRE criterion significantly reduces the number of institutions exceeding it.

Our analysis found that 31 percent of all commercial banks in 2006 exceeded at least one of the concentration levels specified in the supervisory criteria. In 2006, these institutions held $378 billion in outstanding CRE loans, almost 40 percent of all outstanding CRE loans. Beginning in 2007, CRE exposures began to decline and, by the fourth quarter of 2011, the supervisory criteria for concentration levels applied to only 11 percent of institutions, which held $298 billion, or 34 percent, of all outstanding CRE loans. By and large, the institutions with CRE concentrations exceeding the concentration levels in 2011 also exceeded the levels in 2006. Since 2006, only a few banks have been "pushed over" the concentration levels by declining capital.

During the three-year economic downturn, banks with high CRE concentration levels proved to be far more susceptible to failure. Using call report data and applying the supervisory criteria for concentration levels, this paper identifies several findings about the effect of CRE lending on bank performance during the recent market downturn. These findings include:

  • Among banks that exceeded both supervisory criteria, 23 percent failed during the three-year economic downturn, compared with 0.5 percent of banks for which neither of the criteria was exceeded. In particular, 13 percent of banks that exceeded the Construction criterion failed. Banks exceeding the Construction criterion alone accounted for an estimated 80 percent of the losses to the Federal Deposit Insurance Corporation insurance fund from 2007 to 2011.
  • Banks that exceeded the supervisory criteria on CRE concentration levels were more likely than banks that did not exceed the criteria to shrink the size of their CRE portfolios from 2008 to 2011, primarily by reducing their holdings of Construction loans.
  • A non-trivial number of banks exceeding the supervisory criteria on concentration levels in 2007 continued to increase their CRE concentrations through 2011. This was consistent with the guidance's absence of hard caps on CRE concentrations.
  • Banks that exceeded the supervisory criteria on CRE concentrations tended to experience greater deterioration in condition as assessed by market participants. Our analysis reveals that banks with higher CRE concentrations experienced larger declines in their market capital ratio (MCR) during the recent economic downturn.


Last update: May 2, 2013

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