FDIC cautions financial institutions in new advisory letter.
The Federal Deposit Insurance Corporation (FDIC) has released a crucial advisory for banks, highlighting the need for robust risk management in commercial real estate (CRE) lending. This letter replaces the 2008 version, Managing Commercial Real Estate Concentrations in a Challenging Environment, underscoring the significance of strong capital, appropriate credit loss allowances, and effective risk management practices amid challenging economic conditions.
The FDIC draws attention to historical instances, such as the banking crises of the 1980s and 2008-2013, where weak risk management in CRE lending contributed to substantial credit losses and bank failures. The current economic environment, influenced by factors like the COVID-19 pandemic and rising interest rates, has increased concerns about CRE sectors. Rising vacancy rates, especially in the office sector, and potential challenges in refinancing office and multi-family loans are areas of particular focus.
The advisory letter outlines six key risk-management actions for institutions with significant CRE concentrations:
- Maintain strong capital levels,
- Ensure that credit loss allowances are appropriate,
- Manage construction and development (C&D) and CRE loan portfolios closely,
- Maintain updated financial and analytical information,
- Bolster the loan workout infrastructure, and
- Maintain adequate liquidity and diverse funding sources.
It underscores the importance of close management of CRE portfolios, stress testing, and maintaining updated financial and analytical information. Additionally, institutions are urged to bolster their loan workout infrastructure and ensure adequate liquidity and diverse funding sources.
As Doreen Eberley, Director of the Division of Risk Management Supervision notes, “Institutions are encouraged to continue making construction and development loans (C&D) and having CRE credit available in their communities using prudent lending standards.” The FDIC letter provides a comprehensive guide to select FDIC regulations and supervisory guidance, offering financial institutions valuable insights into navigating CRE challenges in the current economic climate.
“This FDIC letter clearly demonstrates the challenges the hospitality sector will continue to experience in 2024 when seeking construction loans, acquisitions loans, or even refinancing assets” says Suraj Bhakta, CEO and Chief Legal Counsel of NewGen Advisory. He further states, “The hotel assets will be scrutinized when underwriting any new loan. Hoteliers should expect lenders to implement higher debt coverage ratios, increase cross-collateralization, and adjustments to the loan to value of each asset.”
For additional insights on effectively managing concentrations in commercial real estate amid challenging economic environments, please read this document or contact us.