After nearly a year of deliberation, the OCC, FDIC, and Federal Reserve issued their joint “guidance” in December 2006, regarding bank concentrations in commercial real estate (CRE). The guidance establishes a supervisory screen for “profiling” institutions by their CRE concentration and CRE growth, which triggers further regulatory scrutiny for adequacy of institutional controls and management of the CRE loan process and portfolio. Noticeably absent is the OTS, which elected to take a different approach independent of its federal counterparts.

Some are concerned that the guidance adversely impacts small-to-midsize institutions and may result in a self-fulfilling prophecy in terms of its impact on CRE values. While the guidance may simply reflect what has been agency policy for some time, the fact that it has now been issued as a joint “guidance” is indicative of the seriousness with which the agencies treat this issue and the likely increased supervisory (and market) focus on CRE concentrations. It is also consistent with the enhanced agency focus on sound risk management and controls, and analysis of capital adequacy as a function of risk.

What brought this about, and how is it likely to impact banks?


The focus of the guidance is primarily on small to mid-size institutions. According to agency statistics, CRE loans in banks with assets between $100 million and $1 billion doubled from 1993 to 2006, from 156 percent of aggregate risk-based capital to 318 percent. During the same period, CRE loans in banks from $1 billion in assets to $10 billion in assets rose from 127 percent to 300 percent.

Overall national CRE debt grew from $952 billion to $2.3 trillion, with some banks holding CRE loans in excess of 700 percent of capital.

It is important to note, however, that the guidance impacts all institutions regardless of size.

What constitutes “Commercial Real Estate” for purposes of the guidance?

CRE is basically defined as loans secured by real estate for (i) construction, land development, and other land loans; (ii) multi-family residential properties; and (iii) non-farm nonresidential properties.

CRE loans are those loans where cash flow from the real estate is the primary source of repayment, rather than loans where real estate is a secondary source of repayment or is taken as collateral through an abundance of caution.

The scope of the guidance is intended to be broad and to include loans that fall within the stated purpose of the guidance and the nature of the credit exposure, which the guidance is intended to include. When in doubt, prudence should dictate that loans be included in calculations of CRE lending by the institution, rather than engaging in disputes with the agencies over proper categorization.

What are the “triggers” for additional regulatory scrutiny?

The guidance implements a screening process intended to identify institutions with large CRE concentrations, especially those with significant recent rapid growth in CRE credits, as well as those where there is notable exposure to any specific type of CRE.

The guidance provides specific action where;

-aggregate CRE loans for construction, land development and other land represent 100 percent or more of total capital; or where

-aggregate CRE loans as described in the guidance represent 300 percent or more of total capital AND the institution’s CRE portfolio has increased 50 percent or more during the p r i o r 36-month period

The specifications do not represent a “safe harbor” for lending activities falling under the stated parameters, but rather represent a published threshold that agencies will use to target institutions for special scrutiny. Concentration concerns may be triggered by a number of other considerations, and institutions cannot relax their internal controls and credit procedures simply because their CRE concentrations do not reach the thresholds set forth in the guidance.

What happens if my institution hits the regulatory “screen”?

Institutions which hit the agency “screen” (and some that don’t) will be subject to enhanced supervisory scrutiny (and likely by the financial markets and auditors) with respect to the adequacy of their loan and credit management and controls, and will also trigger enhanced regulatory stress-testing of their CRE portfolio. Institutions will be expected to be able to justify and support their CRE positions and the adequacy of their CRE oversight abilities. Those that are unable to do so to the satisfaction of the agencies will face potential supervisory action as well as potential punishment by financial markets due to portfolio risk concerns.

Depending on the institution, a supervisory and/or market-induced slowdown in CRE lending may follow.

What does this mean for lenders and banks?

The guidance reflects existing regulatory concern over the rapid growth in CRE lending by banks across the country. That concern has risen to the level of issuance of a multi-agency “guidance”, which bankers recognize is (for all practical purposes) equivalent to a “regulation” in the examination and supervisory process. Banks must be taking appropriate steps to review their portfolios to assess CRE lending controls and portfolio risk, and they must be prepared to justify their holdings, capital levels and ongoing growth if they expect to continue with aggressive CRE lending.

The focus of the guidance is on safe and sound CRE risk management, which includes adequate board and management oversight of the CRE lending processes and procedures, portfolio management, management information systems, market analysis, stress testing, credit underwriting standards and credit risk review functions.

The guidance does not impose new “lending limits”. Theoretically, it is possible for institutions to maintain CRE portfolios that exceed the standards set forth in the guidance. Institutions intending to do so, however, must be ready, willing and able to withstand the enhanced supervisory and market scrutiny brought about by such activities. The reality is that the pressure will be intense, and financial markets may punish institutions that push the boundaries in the CRE lending arena as much or more than the regulatory agencies.


The guidance is a reflection of the concern with which the agencies continue to view the relatively recent explosive nationwide growth in CRE lending. It is obviously intended to provide notice to the industry that the agencies will scrutinize those activities even more closely going forward.

The markets are also likely to recognize those issues and react accordingly. Institutions with large CRE concentrations and inadequate capital must plan to reduce CRE activities or increase capital. Institutions that choose to maintain large CRE concentrations or continue to grow rapidly in the area of CRE lending must be ready to withstand the inevitable additional supervisory and market scrutiny that is sure to follow.