Figure 6 reports some of the summary results of this analysis. Delinquencies fell in 2021 as pandemic-related government restrictions loosened; the rate has stabilized in recent quarters above pre-pandemic levels. It leaves us asking: whats the distribution of the data across banks? In contrast, the ranking analysis shows that risk-based capital at CRE-concentrated banks grew more rapidly than at the median bank; roughly 75% of them had higher capital growth rates than the median bank for up to five years ahead. As such, the diagnostic accuracy of the serum Cre concentration is not sufficient for a screening test for CKD. Columns (2) and (5) provide a similar set of estimation results for Q1 2021. What is currently billed as a sector-wide CRE crisis is actually more nuanced. Cre/BW ratio ( 100) and incident T2DM was stable in the different subgroups. Owner-occupied CRE loans were not broken out by financial institutions in call report data until 2007; therefore, it was not possible to accurately measure the three-year growth rate of an institution's non-owner-occupied CRE portfolio--and correctly apply the growth component--until late 2010. For example, the percentage of aggregate bank CRE lending that is nonperforming averaged about 6% from 1984 to 1988 and then rose dramatically to 14% in 1990. Key identifies bar chart in order from bottom to top. These developments pose risks to firms with high CRE concentration. Changes in the unemployment rate did not have a significant effect on either of these outcomes. Changes in the unemployment rate becomes insignificant, suggesting that loan modifications in the later stages of the COVID-19 recession may have been driven by lingering effects of earlier labor market disruptions. Commercial Real Estate Concentration Risk The focus on the linkage between Section 4013 loan modification and commercial real estate (CRE) concentration is motivated by findings in the academic literature that CRE lending can pose heightened risk for banks relative to other loan types. The bank may be required to take actions to reduce its concentration risk, such as limiting its new commercial real estate lending, increasing its capital levels, or implementing more robust risk management practices. Figure 1b shows that growth in CRE concentration is largely driven by smaller banks, most notably banks with assets between $10 and $100 billion. Had risk-based capital not increased substantially during the post-crisis period, CRE relative to risk-based capital would be closer to historic highs. Note: Recessions are shaded in light red. The pair of charts in the middle panel of figure 2 repeats this analysis based solely on the construction ratio. At first glance, the consistently rising Sector Aggregate measurement draws concern. Banks and institutions used to say they make a loan and, if there's a loss, they put capital aside. "Nontraditional banking activities and bank failures during the financial crisis". What are small and medium banks doing? For most banks, regulatory reports do not provide detailed CRE exposures at the sector level. Loss rates for non-owner-occupied loans, while still higher than loss rates for owner-occupied loans, were significantly lower than those for construction loans. Multifamily, office, and retail segments are by far the largest, with 34, 25, and 18 percent of all CRE loans respectively. Monetary Base - H.3, Assets and Liabilities of Commercial Banks in the U.S. - Specifically, the guidance identifies two supervisory criteria that could subject an institution to further analysis: The construction concentration criterion focuses exclusively on CLD loans, as those loans are the most likely to result in losses during a downturn. There are a few metrics that regulators use to evaluate the risk of potential loss of a banks portfolio. Additionally, we flag the banks where both the construction concentration ratio and the CRE construction ratio surpass 100% and 300%, respectively. Senior Vice President If we only considered the increases, we would fail to see that it is not quite as concerning relative to the simultaneous decreases. As they debate whether or not current CRE lending practices are an accurate prognosticator, recent Qaravan data tells a far more nuanced story. Importantly, these loss projections and allowances were required to be estimated even for Section 4013 modified loans. Change in Market Capital Ratio. CLD lending is naturally highly cyclical. Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue N.W., Washington, DC 20551, Last Update: The mechanism used to perform the analysis is to compare the rank ordering of the concentrated CRE banks in certain performance categories to the rank ordering of all banks. Capital positions provide a way to assess bank performance that can shed light on the impact of risk-management practices. Figure 1 summarizes these annual distributions using three percentiles. Commercial Real Estate Lending Joint Guidance (December 12, 2006). Roughly half of these banks also saw increases in their capital, with an average change of 22 percent. Supervisory guidance on CRE lending concentrations. Cole, R.A., Gunther, J.W. Pandemic-related retail and hotel stresses are well-known, but risks of future deterioration in office and even multifamily segments due to more work-at-home, combined with sizable regional and community bank exposures to these sectors, could lead to credit losses. Aside from looking at distribution according to the size of banks, we can also consider distribution according to where a bank is located. According to Trepp, the delinquency rate on loans in CMBS securitizations rose from just 2 percent prior to COVID to a peak of 10.3 percent in June 2020 and was still at an elevated 6.5 percent in April 2021. However, Trepp's Anonymized Loan Level Repository (T-ALLR) provides additional granularity for the sample of reporting banks' CRE loans. The typical (median) bank with high CRE concentration (greater than 60 percent of loans) reports that 1.6 percent of loans are modified. Within each decile, were looking at the Median rate of change in CRE Concentration between the lowest point of our recent upward trend, fourth quarter 2013, and the latest data set available, fourth quarter 2019. (1995). The guidance levels used by regulators for bank stress testing and that we use for this analysis are a 300% concentration ratio for all CRE loans and a 100% concentration ratio for just construction loans. While the rate of loan modifications has been decreasing following an abrupt surge in Q2 2020, the allowance dynamics in the CRE portfolios suggest that this loan category continues to be a source of elevated bank risk, warranting continued close monitoring of banks with CRE concentrations and high or growing levels of loan modifications. If you are looking for more CRE lending or banking data, insights, and analytics, request a meeting with a Trepp expert today. This percentage declined to 6% in 1993 and continued to decline through 2000. In the previous downturn, loan modifications generally followed loan delinquencies, whereas during the COVID-19 recession modifications may have prevented a deterioration in loan quality. 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). Additionally, considering the rates within cohorts, we can see that while CRE Concentration is consistently on the rise, the rate of concentration increase is not evenly distributed across a sectors many banks. What that chart does not depict is how many banks are causing this rise. Total loan data excludes Payment Protection Program (PPP) loans. While there has been a significant reduction in the number of banks close to or above at least one of the thresholds, banks that remain close to or exceeding the thresholds still account for nearly half of all outstanding CRE loans. However, although shares were down, PacWests press release on May 4th tried to reassure investors that deposit flows have been stable, with insured deposits even higher than previous periods, while also noting that they are continuously review[ing] strategic options.. Return to text, 6. We believe this indicates that there is a core group of banks that specializes in, or is particularly dependent on, CRE lending. The purpose of the guidance is to address banking institutions' increased concentrations of CRE loans relative to their capital. The definitions of concentrated, nearly concentrated, and unconcentrated here depend only on the ratio of CLD loans to total capital. A similar result was found for their overall NPL growth. Many banks with high concentrations that managed to survive the recession benefitted from being outside the most overheated and affected markets. In terms of capital, CRE-concentrated banks have slightly lower capital ratios, although they also have exhibited higher capital growth rates. Creatinine is a waste product produced by your muscle cells as they use creatine (a natural chemical that gives your muscles energy). Foreign Banks, Charge-Off and Delinquency Rates on Loans and Leases at With the contraction in bank liquidity and lending and an increased radar for bank stress testing from regulators due to the recent turmoil, banks with the highest CRE concentrations could see a pull-back on their lending books to allow their debt to roll off. Commercial real estate (CRE), such as office towers, shopping centers, and apartment buildings, makes up approximately one-third of the total value of U.S. real estate. We define CRE loan concentration for a given . of banks with $100 billion or more in total assets. Instead, by calculating the ratio for each bank in a sector during a given period, we can identify the median value, which gives us a clearer depiction of how the average bank, is performing within a sector and a better sense of how banks are performing individually. All reporting firms. 2. Timed . Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised)(PDF) (April 7, 2020). Sources: Q1 2021 FFIEC Call Reports. In December 2006, the federal banking regulatory agencies issued new guidance on sound risk management in response to recent increases in CRE loan concentrations. Disclaimer: FEDS Notes are articles in which Board staff offer their own views and present analysis on a range of topics in economics and finance. FDIC: Supervisory Insights - Managing Commercial Real Estate Concentrations Return to text, 4. Having considered how we measure increased CRE Concentration and how that concentration is distributed, we still do not know if that distribution is amongst particular sizes of banks. Rising rates of CRE Concentration are taken to be an indicator of impending economic crisis.