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News Release 2008-9 | January 31, 2008

Comptroller Dugan Expresses Concern About Commercial Real Estate Concentrations

MIAMI—Comptroller of the Currency John C. Dugan told a bank conference today that the OCC is focusing increased attention on problems arising from high community bank concentrations in commercial real estate (CRE) at a time of significant market disruptions and declining house and condominium sales and values.

"The combination of these conditions is putting considerable stress on one particular category of commercial real estate lending: residential construction and development – and other categories of CRE loans will feel similar stress if general economic activity slows materially," Mr. Dugan said in a speech before a meeting of the Florida Bankers Association.

In the area of construction and development (C&D) loans, nonperforming loans in community national banks amounted to 1.96 percent of the total at the end of the third quarter, double the rate of the year before.

"Although starting from an admittedly very low baseline, an increase like this – over 100 percent in a single year – is clearly a trend that we need to monitor closely," Mr. Dugan said.

The OCC will take a number of steps to deal with the problem, he said. "There will be more frequent interaction between supervisors and banks with concentrations in CRE loans that are declining in quality," Comptroller Dugan said. "There will be more criticized assets; increases to loan loss reserves; and more problem banks."

Mr. Dugan emphasized that the OCC’s objective has been to "get at problems early when they’re smaller and more easily managed, and to keep communications lines open as we do."

The OCC expects banks with CRE concentrations to make realistic assessments of their portfolio based on current market conditions, and to make necessary adjustments as market conditions change.

"For those of you in stressed markets, it will almost certainly require you to downgrade more of your assets, increase loan loss provisions, and reassess the adequacy of bank capital," he said. "These are normal, expected steps to take in these circumstances, and I can’t stress enough how important it is for you to make these realistic judgments yourselves, based on sound credit administration practices, instead of forcing our examiners to try and make these same judgments in the first instance."

In recent years, the Comptroller said, banks had become too complacent regarding the potential for significant stresses in these markets, and CRE concentrations rose significantly in many banks. The ratio of commercial real estate loans to capital has nearly doubled in the past six years, he said.

"Even more significant than this overall industry statistic is the number of individual banks that have especially large concentrations," Mr. Dugan added. "Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital."

The OCC has been closely monitoring commercial real estate lending for the past four years, and assigned highly experienced examiners to look horizontally across banks with higher CRE concentrations as a means of identifying best practices and evaluating asset quality in this lending area.

While the OCC has found signs of improvement in some risk management practices, examiners have also continued to observe a number of risk management deficiencies that are a cause for concern, Mr. Dugan said. In particular, he said, the horizontal reviews have shown that many banks with significant CRE concentrations have not updated appraisals regularly, which makes it hard to assess credit quality.

"In terms of asset quality, our horizontal reviews have indeed confirmed a significant increase in the number of problem residential construction and development loans in community banks across the country," the Comptroller added.

Mr. Dugan told the bank association that the OCC is prepared to work with banks that have high levels of classified CRE assets, and that the agency’s goal is to help banks manage through the attendant issues and problems," he said.

"For the industry’s part, we expect bank management to be realistic about identifying problem assets themselves, so that our examiners are not forced into the position of having to do this for them," he said. "The idea is to recognize problems early and manage through them, with good and continual communications between examiners and bankers, before the problems fester and get worse," he added.

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