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NR 2006-45
Contact: Robert M. Garsson
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Comptroller Dugan Tells Bankers Commercial Real Estate Concentrations Raise Concerns, but Can Be Safe if Effectively Managed

NEW YORK – Comptroller of the Currency John C. Dugan told a conference of bankers today that while concentrations in commercial real estate lending do raise safety and soundness concerns, bank regulators believe they can be safe if they are effectively managed.

“Our message is not, ‘Cut back on commercial real estate loans’,” Mr. Dugan said in a speech to the New York Bankers Association.  “Instead it is this:  ‘You can have concentrations in commercial real estate loans, but only if you have the risk management and capital you need to address the increased risk.’   And in terms of  ‘the risk management and capital you need,’ we’re not talking about expertise or capital levels that are out of reach or impractical for community and mid-size bankers – because many of you already have both.”

The Comptroller noted that 30 percent of national banks hold commercial real estate loans in amounts exceeding 300 percent of capital and said that nearly all of these institutions are mid-size or community banks.  Commercial real estate lending has historically been a volatile business, he noted, adding that it clearly played a role in the banking crisis of the late 1980s and early 1990s.

“The degree to which banks participated in the run-up of the commercial real estate market in the early ‘80s was one of the best predictors of subsequent bank failure,” the Comptroller said.  “On average, banks that failed had nearly three times as many commercial real estate loans as a percentage of their total assets as banks that did not fail.”

In the last several years, he said, the OCC has found erosion in some key areas: lengthening maturities, increasing policy exceptions, narrowing spreads, and a lack of independence and quality control in the appraisal process.  In addition, the OCC found that risk management practices were not keeping up with the growth in commercial real estate concentrations. 

Although it was these recent trends that led regulators to propose new guidance, the proposal is, at its core, simply a restatement and amplification of the supervisory guidance that the agencies developed in the wake of widespread bank failures precipitated by commercial real estate lending less than 20 years ago, he said.

“What the new guidance does for the first time is provide a simple definition of what we mean by commercial real estate concentrations,” Comptroller Dugan said.  “The definition is intended to answer the questions we have received over the years from many bankers frustrated with the ambiguity and lack of clarity of our previous guidance.”

The proposed guidance provides more straightforward concentration thresholds that, once crossed, trigger the need for enhanced risk management and capital levels, he said.  One threshold is defined as those commercial real estate loans made for construction, land development, or other land that in the aggregate exceed 100 percent of capital.  The second threshold applies when all commercial real estate loans made by a bank exceed 300 percent of capital.

The Comptroller said the benchmarks are not hard caps that would force banks to cut their commercial real estate lending.  “Far from being caps, these numbers are simply screens to determine where enhanced risk management and adequate capital is needed, as the guidance makes clear,” Mr. Dugan said.  “We are emphasizing this very point – that the thresholds are triggers for better prudential practices, not caps – in discussions with our examiners in every region of the country.”

“Our focus in applying this guidance will be first and foremost on risk management practices,” Mr. Dugan said.  “To the extent that an institution with a concentration exceeding one of the thresholds has enhanced risk management practices in place, or is moving in that direction, our concern with increased capital is greatly reduced.”

Moreover, the Comptroller said, the overwhelming majority of institutions with real estate concentrations already hold capital cushions that exceed regulatory minimums and that these institutions generally should not be affected by the capital adequacy requirement in the proposed guidance.

“Needless to say, when it comes to commercial real estate, we as regulators and you as lenders should be doing all that we can to avoid both increased bank failures and a credit crunch,” Comptroller Dugan said.  “The best way to do that is to address smaller concerns effectively before they grow into much bigger problems that precipitate more extreme actions and reactions.  That’s precisely what the proposed guidance is intended to do.

“In sum, we recognize that commercial real estate lending has been and will continue to be a very good business for banks – all banks – provided that it is effectively managed,” Mr. Dugan concluded.  “At the end of the day, that is the very essence of the proposed guidance. 

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