We have noted increasing concentrations of credit within the SHP & Co. peer group. Many clients have expanded their non-farm non-residential portfolios (both owner & non-owner occupied) as well as their AD&C loans. Readers are reminded of the joint 2006 Regulatory publication (Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices) in which the Regulatory bodies detailed CRE concentration levels at which heightened scrutiny could result:
Total reported loans for construction, land development, and other land represent 100 percent or more of the institution's total capital; or
Total commercial real estate loans as defined in the Guidance* 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.
*Per the Guidance: “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.”
The most recent Supervisory Insight issue focuses on three areas of loan concentrations, CRE, agriculture and oil & gas, and indicates its discussion is applicable to other loan portfolio segments representing concentrations. In reading the Winter SI issue, a look back at the OIG’s Comprehensive Study on the Impact of the Failure of Insured Depository Institutions will provide some useful background information. The Report’s findings included:
The markets drove behaviors that were not always prudent. Banks expanded lending to keep pace with rapid growth in construction and real estate development, rising mortgage demands, and increased competition. Many of the banks that failed did so because management relaxed underwriting standards and did not implement adequate oversight and controls.
…[Regulators] could have provided earlier and greater supervisory attention to troubled institutions that failed.
The majority of community banks failed as a result of aggressive growth, asset concentrations, poor underwriting, and deficient credit administration coupled with declining real estate values.
The SI highlights the following weaknesses (in addition to some other weaknesses noted) within CRE portfolios:
The absence of, or unsupported or excessive, board-approved limits for CRE portfolios or segments thereof;
Inadequate reporting of concentrations to the institution’s board or relevant committee and lack of documented discussion regarding concentrations in board or relevant committee meetings;
Weaknesses in underwriting practices, including the following:
Numerous exceptions to the institution’s loan policy;
Inadequate tracking of loan policy exceptions;
Unsupported cash flow projections;
Lack of global cash flow analysis of guarantors; and
Excessive or inappropriate use of cash-out financing and interest only payment terms;
Insufficient internal loan review coverage of CRE activities or improper risk ratings;
Appraisal review programs lacking adequate independence or expertise of reviewers
Ineffective construction loan oversight, including lack of timely inspections or adequate disbursement controls…
The SI includes what could be considered a ‘word to the wise’: ‘When management cannot or does not achieve reasonable diversification, risk-management programs that may otherwise be adequate may require increased oversight; stronger credit- and liquidity-management practices; enhanced management information systems and reporting; more robust loan review and allowance for loan and lease losses (ALLL) policies and practices; and possibly, higher capital levels.’
For reference, the following concentration information was derived from Uniform Bank Performance data (as of December 31, 2016 for all institutions chartered in the states of Alabama, Florida, Georgia, South Carolina, and Tennessee, as well as national averages):
This information can be found using tools from the FFIEC at https://www.ffiec.gov or please contact us for assistance with or request for additional detail / trends, or overall detail regarding other states.