From 888c23e0aac95602b3fafb05e48d5a00473cad15 Mon Sep 17 00:00:00 2001 From: jacquie48e879 Date: Thu, 12 Jun 2025 23:43:47 +0200 Subject: [PATCH] Add 'Community Banking Connections' --- Community-Banking-Connections.md | 46 ++++++++++++++++++++++++++++++++ 1 file changed, 46 insertions(+) create mode 100644 Community-Banking-Connections.md diff --git a/Community-Banking-Connections.md b/Community-Banking-Connections.md new file mode 100644 index 0000000..327d2eb --- /dev/null +++ b/Community-Banking-Connections.md @@ -0,0 +1,46 @@ +[cbc.ca](https://www.cbc.ca/1.5063204)
While the banking industry is widely considered as more resistant today than it was heading into the financial crisis of 2007-2009,1 the industrial real estate (CRE) landscape has changed considerably considering that the start of the COVID-19 pandemic. This new landscape, one characterized by a higher rates of interest environment and hybrid work, will affect CRE market conditions. Considered that community and regional banks tend to have higher CRE concentrations than large companies (Figure 1), smaller sized banks should remain abreast of existing patterns, emerging danger factors, and opportunities to update CRE concentration danger management.2,3
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Several current industry forums carried out by the Federal Reserve System and specific Reserve Banks have actually discussed various aspects of CRE. This post intends to aggregate key takeaways from these numerous online forums, in addition to from our recent supervisory experiences, and to share noteworthy trends in the CRE market and pertinent threat aspects. Further, this post attends to the value of proactively managing concentration risk in an extremely dynamic credit environment and supplies numerous best practices that highlight how threat managers can consider Supervision and Regulation (SR) letter 07-1, "Interagency Guidance on Concentrations in Commercial Real Estate," 4 in today's landscape.
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Market Conditions and Trends
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Context
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Let's put all of this into perspective. Since December 31, 2022, 31 percent of the insured depository organizations reported a concentration in CRE loans.5 The majority of these financial organizations were community and local banks, making them a vital financing source for [CRE credit](https://muigaicommercial.com).6 This figure is lower than it was during the monetary crisis of 2007-2009, however it has been increasing over the past year (the November 2022 Supervision and Regulation Report mentioned that it was 28 percent on June 30, 2022). Throughout 2022, CRE efficiency metrics held up well, and lending activity remained robust. However, there were signs of credit degeneration, as CRE loans 30-89 days overdue increased year over year for CRE-concentrated banks (Figure 2). That said, past due metrics are lagging indications of a customer's monetary challenge. Therefore, it is crucial for banks to implement and keep proactive risk management practices - gone over in more information later on in this post - that can inform bank management to degrading efficiency.
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Noteworthy Trends
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Most of the buzz in the CRE area coming out of the pandemic has been around the office sector, and for good reason. A current study from business teachers at Columbia University and New York University discovered that the value of U.S. office complex could plunge 39 percent, or $454 billion, in the coming years.7 This might be triggered by recent patterns, such as renters not restoring their leases as employees go totally remote or occupants renewing their leases for less area. In some severe examples, companies are quiting area that they leased only months earlier - a clear sign of how rapidly the marketplace can turn in some places. The battle to fill empty office is a nationwide pattern. The national job rate is at a record 19.1 percent - Chicago, Houston, and San Francisco are all above 20 percent - and the [quantity](https://sinva.vn) of workplace rented in the United States in the 3rd quarter of 2022 was almost a third below the quarterly average for 2018 and 2019.
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Despite record jobs, banks have benefited therefore far from workplace loans supported by lengthy leases that insulate them from sudden degeneration in their portfolios. Recently, some big banks have started to offer their office loans to restrict their direct exposure.8 The sizable amount of office debt maturing in the next one to three years might develop maturity and refinance risks for banks, depending on the financial stability and health of their debtors.9
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In addition to current actions taken by big companies, patterns in the CRE bond market are another important sign of market belief associated to CRE and, specifically, to the workplace sector. For example, the stock prices of big openly traded proprietors and developers are close to or below their pandemic lows, [underperforming](https://www.defclarea.org) the wider stock market by a substantial margin. Some bonds backed by workplace loans are likewise revealing signs of stress. The Wall Street Journal released an article highlighting this trend and the pressure on realty values, keeping in mind that this activity in the [CRE bond](https://listin.my) market is the current sign that the increasing rate of interest are impacting the business residential or commercial property sector.10 Property funds usually base their assessments on appraisals, which can be sluggish to [reflect progressing](https://horizonstays.co.uk) market conditions. This has actually kept fund assessments high, even as the real estate market has weakened, underscoring the challenges that many community banks deal with in identifying the current market worth of CRE residential or commercial properties.
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In addition, the CRE outlook is being affected by greater dependence on remote work, which is consequently impacting the usage case for large workplace structures. Many business workplace designers are seeing the shifts in how and where individuals work - and the accompanying patterns in the office sector - as chances to consider alternate usages for workplace or commercial properties. Therefore, banks should consider the potential implications of this remote work pattern on the need for workplace and, in turn, the possession quality of their office loans.
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Key Risk Factors to Watch
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A [confluence](https://lebanon-realestate.org) of factors has caused a number of crucial threats affecting the CRE sector that deserve highlighting.
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Maturity/refinance risk: Many fixed-rate office loans will be maturing in the next couple of years. Borrowers that were locked into low rate of interest might deal with payment obstacles when their loans reprice at much higher rates - sometimes, double the original rate. Also, future refinance activity might need an extra equity contribution, potentially creating more financial stress for customers. Some banks have started using bridge funding to tide over particular borrowers till rates reverse course. +Increasing risk to net operating earnings (NOI): Market participants are citing increasing costs for items such as energies, residential or commercial property taxes, upkeep, insurance coverage, and labor as an issue because of increased inflation levels. Inflation could trigger a structure's operating costs to increase faster than rental earnings, putting pressure on NOI. +Declining possession worth: CRE residential or commercial properties have just recently experienced considerable price modifications relative to pre-pandemic times. An Ask the Fed session on CRE noted that appraisals (industrial/office) are below peak prices by as much as 30 percent in some sectors.11 This triggers a concern for the loan-to-value (LTV) ratio at [origination](https://www.agentjill.com) and can easily put banks over their policy limits or run the risk of cravings. Another factor affecting property worths is low and delayed capitalization (cap) rates. Industry participants are having a difficult time determining cap rates in the present environment since of poor information, less transactions, fast rate movements, and the unpredictable rate of interest course. If cap rates remain low and interest rates surpass them, it might result in an unfavorable leverage circumstance for debtors. However, financiers anticipate to see boosts in cap rates, which will negatively affect appraisals, according to the CRE services and financial investment company Coldwell Banker Richard Ellis (CBRE).12
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Modernizing Concentration Risk Management
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Background
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In early 2007, after observing the pattern of increasing concentrations in CRE for numerous years, the federal banking firms launched SR letter 07-1, "Interagency Guidance on Concentrations in Commercial Real Estate." 13 While the assistance did not set limits on bank CRE concentration levels, it encouraged banks to improve their risk management in order to handle and control CRE concentration threats.
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Key Elements to a Robust CRE Risk Management Program
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Many banks have because taken actions to align their CRE danger management framework with the crucial elements from the assistance:
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- Board and management oversight +- Portfolio management +- Management info system (MIS). +- Market analysis. +- Credit underwriting requirements. +- Portfolio tension screening and level of sensitivity analysis. +- Credit risk evaluation function
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Over 15 years later on, these fundamental components still form the basis of a robust CRE danger management program. An efficient danger management program develops with the altering danger profile of an institution. The following subsections expand on 5 of the 7 components kept in mind in SR letter 07-1 and aim to highlight some finest practices worth considering in this vibrant market environment that may improve and reinforce a bank's existing structure.
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Management Information System
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A robust MIS supplies a bank's board of directors and management with the tools needed to proactively keep track of and manage CRE concentration risk. While lots of banks already have an MIS that stratifies the CRE portfolio by market, residential or commercial property, and place, management may want to consider additional ways to segment the CRE loan portfolio. For instance, management may consider reporting customers facing increased refinance danger due to rate of interest fluctuations. This details would assist a bank in identifying potential re-finance threat, might assist guarantee the precision of danger ratings, and would help with proactive discussions with potential problem borrowers.
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Similarly, management might wish to evaluate transactions financed during the realty evaluation peak to determine residential or commercial properties that might currently be more delicate to near-term appraisal pressure or stabilization. Additionally, including data points, such as cap rates, into existing MIS might provide useful information to the bank management and bank lending institutions.
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Some banks have actually implemented an enhanced MIS by utilizing central lease tracking [systems](https://www.properush.com) that track lease expirations. This kind of data (especially relevant for workplace and retail areas) provides details that [enables loan](https://horizonstays.co.uk) providers to take a proactive technique to keeping track of for potential concerns for a specific CRE loan.
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Market Analysis
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As noted previously, market conditions, and the resulting credit threat, differ throughout locations and residential or commercial property types. To the extent that data and details are available to an organization, bank management might consider additional segmenting market analysis data to best determine trends and danger aspects. In large markets, such as Washington, D.C., or Atlanta, a more granular breakdown by submarkets (e.g., central company district or rural) may be relevant.
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However, in more rural counties, where offered information are restricted, banks might think about engaging with their local appraisal companies, contractors, or other community development groups for pattern information or anecdotes. Additionally, the Federal Reserve Bank of St. Louis preserves the Federal Reserve Economic Data (FRED), a public database with time series details at the county and national levels.14
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The very best market analysis is not done in a vacuum. If meaningful patterns are determined, they may notify a bank's loaning method or be integrated into tension testing and capital planning.
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Credit Underwriting Standards
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During durations of market duress, it ends up being significantly essential for lending institutions to completely understand the financial condition of customers. Performing worldwide money flow analyses can [guarantee](https://homes.lc) that banks understand about dedications their customers may need to other banks to reduce the risk of loss. Lenders should likewise consider whether low cap rates are pumping up residential or commercial property valuations, and they need to completely examine appraisals to understand presumptions and development forecasts. An effective loan underwriting process thinks about stress/sensitivity analyses to much better capture the potential changes in market conditions that could impact the ability of CRE residential or commercial properties to produce enough capital to cover financial obligation service. For instance, in addition to the usual requirements (financial obligation service coverage ratio and LTV ratio), a tension test might include a breakeven analysis for a residential or commercial property's net operating income by increasing business expenses or decreasing rents.
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A sound danger management process ought to determine and monitor exceptions to a bank's financing policies, such as loans with longer interest-only durations on supported CRE residential or commercial properties, a greater reliance on guarantor support, nonrecourse loans, or other deviations from internal loan policies. In addition, a bank's MIS need to provide enough information for a bank's board of directors and senior management to examine dangers in CRE loan portfolios and determine the volume and trend of exceptions to loan policies.
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Additionally, as residential or commercial property conversions (believe office to multifamily) continue to emerge in significant markets, lenders might have proactive conversations with investor, owners, and operators about alternative usages of property area. Identifying alternative plans for a residential or commercial property early could help banks get ahead of the curve and minimize the danger of loss.
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Portfolio Stress Testing and Sensitivity Analysis
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Since the start of the pandemic, many banks have actually revamped their stress tests to focus more greatly on the CRE residential or commercial properties most negatively impacted, such as hotels, workplace, and retail. While this focus may still matter in some geographic areas, efficient stress tests need to progress to consider new kinds of post-pandemic situations. As talked about in the CRE-related Ask the Fed webinar discussed previously, 54 percent of the participants noted that the top CRE issue for their bank was maturity/refinance risk, followed by negative take advantage of (18 percent) and the failure to precisely develop CRE worths (14 percent). Adjusting existing stress tests to capture the worst of these concerns might supply insightful details to notify capital planning. This process could also offer loan officers information about borrowers who are especially susceptible to interest rate increases and, thus, proactively inform workout strategies for these customers.
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Board and Management Oversight
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Just like any threat stripe, a bank's board of directors is eventually accountable for setting the danger hunger for the organization. For CRE concentration risk management, this means establishing policies, procedures, risk limits, and loaning strategies. Further, directors and management need an appropriate MIS that supplies enough information to assess a bank's CRE threat direct exposure. While all of the items discussed earlier have the potential to strengthen a bank's concentration danger management framework, the bank's board of directors is accountable for developing the danger profile of the institution. Further, an efficient board approves policies, such as the tactical strategy and capital plan, that align with the threat profile of the institution by thinking about concentration limitations and sublimits, in addition to underwriting requirements.
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Community banks continue to hold significant concentrations of CRE, while many market indicators and emerging patterns point to a combined performance that is dependent on residential or commercial property types and location. As market gamers adjust to today's developing environment, bankers require to remain alert to modifications in CRE market conditions and the danger profiles of their CRE loan portfolios. Adapting concentration threat management practices in this altering landscape will guarantee that banks are prepared to weather any prospective storms on the horizon.
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* The authors thank Bryson Alexander, research expert, Federal Reserve Bank of Richmond \ No newline at end of file