Dive Brief:

• The Federal Deposit Insurance Corp. (FDIC) will take a closer look at banks with significant exposure to commercial real estate (CRE) loans, the agency said last week, citing the economic impact of the COVID-19 pandemic.
• Examiners will increase their focus on CRE transaction testing in the upcoming examination cycle, “given the uncertain long-term impacts of changes in work and commerce in the wake of the pandemic, the effects of rising interest rates, inflationary pressures, and supply chain issues,” the regulator said Wednesday in its Supervisory Insights bulletin.
• Closer scrutiny of commercial real estate loans comes as the volume of CRE loans held by banks peaked at more than $2.7 trillion at the end of 2021, the FDIC said.

Dive Insight:

More than 98% of banks engage in commercial real estate lending, and commercial real estate loans are the largest loan portfolio type for nearly half of all banks, the FDIC said in its report. 

While dollar volume of CRE loans is at a historic high, and a growing number of banks report CRE concentrations, lending concentrations “are not by definition problematic,” the FDIC said.

“The majority of banks with CRE loan concentrations are satisfactorily rated. Nevertheless, CRE loan concentrations add dimensions of risk that necessitate continued attention from banks and their regulators, especially as the pandemic lingers and uncertainties remain,” the regulator said.

While 2021 saw improvement in the commercial property market compared with 2020, the FDIC highlighted certain areas hit hard during the pandemic that have been slow to recover.

“[S]ome sectors, such as hotel (particularly those that are business/convention-oriented) and office, and some geographies, such as the Manhattan borough of New York City, lagged,” said the FDIC, which also referenced a decline in shopping mall valuations in 2021. “Pandemic impacts and other uncertainties remain poised to potentially affect CRE property values.”

The FDIC said its bank examiners have found areas of concern in some banks’ CRE loans, including a lack of sufficient risk analysis, despite elevated risk profiles.

“Others have not addressed the board of directors’ expectations with respect to such testing and analysis in their policies,” the regulator said. “In addition, examiners observed that the design and complexity of some testing or analysis methods were inconsistent with the nature of the CRE portfolios and lending environments.”

“These inconsistencies may ultimately weaken the usefulness of the results for the bank’s board of directors and management,” the FDIC said.

As the FDIC increases its focus on CRE lending, examiners will test newer CRE credits, credits within stressed sub-categories and geographies and credits with payments vulnerable to rising rates and rising costs, the regulator said.