The FDIC issued guidance (FIL-22-2008, the “Letter”) concerning managing commercial real estate (“CRE”) concentrations in a challenging economic environment. The Letter emphasizes that financial institutions (“FIs,” and each an “FI”) with CRE concentrations need to maintain strong capital and loan loss allowance levels and robust credit risk management practices. The FDIC said that the Letter is intended to complement the December 6, 2006 Interagency Guidance on CRE lending and the December 13, 2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses (“ALL”).
In the Letter, the FDIC makes five recommendations to FIs with significant CRE concentrations:
Increase or Maintain Strong Capital Levels. The letter states that FIs with CRE concentrations need strong capital to protect them against unexpected losses, particularly in stressed markets. The FDIC notes that capital protection for construction and development (“C&D”) and CRE concentrations should be “a strategic priority” that is taken into account before an FI’s Board declares a cash dividend.
Ensure that Loan Loss Allowances are Appropriately Strong. The Letter states that, at least quarterly, an FI should confirm that its ALL meets GAAP requirements, analyze the collectability of its CRE portfolio and confirm that its ALL covers “estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses in the remainder of the loan portfolio.”
Manage C&D and CRE Loan Portfolios Closely. The Letter urges FIs to maintain prudent lending policies that cover C&D and CRE concentrations. The FI’s information systems should provide meaningful data on concentration levels and market conditions. An FI’s credit review and risk rating system should be strong and provide early identification of asset quality deterioration. Furthermore, interest reserves and loan extension accommodations should be monitored and reflected in loan ratings and credit reviews.
Maintain Updated Financial and Analytical Information. The FDIC states that FIs with CRE concentrations should have recent borrower financial statements, guarantor personal statements, tax returns and other pertinent financial and related information relevant to the credit. The Letter stresses that appraisals should be updated, as necessary.
- Bolster the Loan Workout Infrastructure. The Letter stresses that FIs should have both sufficient staff and access to individuals with the needed skill sets to manage an increase in problem loans and loan workouts. The Letter further states that management of an FI should “develop a ready network of legal, appraisal, real estate brokerage and property management professionals” to address needs associated with higher levels of problem assets.