Commercial Real Estate - FDIC
Comptroller of the Currency Administrator of National Banks
Commercial Real Estate 2011 Interagency MDI Conference June 15-16, 2011 Darrin Benhart Director - Commercial Credit Policy
Agenda •
CRE Portfolio – Concentration/Volume – Performance
•
Other Issues in Commercial Real Estate – Stress Testing – Interagency Workout Guidance – Appraisals
•
Troubled Debt Restructures – Trends – Financial Distress/Concessions
•
OREO – Trends – Guidance on OREO exchanges
•
Credit Underwriting Survey Commercial Credit Policy
2
Commercial Loan Balances, National Banks, $Bn
Commercial Credit Policy
3
CRE as a % of Capital
Commercial Credit Policy
4
CRE Portfolio Performance -- Nonperforming 10.00% 9.00%
All National Banks
Large Banks
Midsize Banks
Community Banks
20 Yr Ave All National Banks 8.00% 7.66% 7.37% 7.25%
7.00% 6.00%
5.60% 5.00% 4.00% 3.24%
3.00% 2.00% 1.00%
Commercial Credit Policy
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
4Q07
3Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
4Q05
3Q05
2Q05
1Q05
4Q04
3Q04
2Q04
1Q04
4Q03
3Q03
2Q03
1Q03
4Q02
3Q02
2Q02
1Q02
4Q01
0.00%
5
CRE Portfolio Performance – Ann. Net Losses 7.00%
6.00%
All National Banks
Large Banks
Midsize Banks
Community Banks
20 Yr Ave All National Banks
5.00%
4.00%
3.00% 1.60% 1.52% 1.52% 1.38%
2.00%
1.00% 0.71%
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
4Q07
3Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
4Q05
3Q05
2Q05
1Q05
4Q04
3Q04
2Q04
1Q04
4Q03
3Q03
2Q03
1Q03
4Q02
3Q02
2Q02
1Q02
4Q01
0.00%
‐1.00%
Commercial Credit Policy
6
National vacancy rates starting to recover but will improve slowly
Vacancy (%)
Office
Retail Warehouse
Apartment
Forecast
Source: Property & Portfolio Research; 2011Q1 forecast
Commercial Credit Policy
7
Net operating income (NOI) will recover slowly Annual NOI growth
Source: Property & Portfolio Research; 2011Q1 forecast
Commercial Credit Policy
8
Cap rates flat or down slightly across property types
Source: Real Capital Analytics; through March 2011; transaction-based
Commercial Credit Policy
9
Spread Between CRE Cap Rate and 10 Year Treasury
Commercial Credit Policy
10
Property values will recover slowly with prior peaks well out of reach over Property value % of recent peak the next few years
70% 65%
65%
Source: Property & Portfolio Research; 2011Q1 forecast
Commercial Credit Policy
11
Stress Testing • What is stress testing? – Sensitivity Analysis – Portfolio Stress Testing – Enterprise (Macro) Stress Testing
• Approaches – Top Down • Macroeconomic based • Portfolio-wide assumptions
– Bottom Up • Loan level assumptions • “Roll-up” of results • Can tie assumptions to macro scenarios
• Validation – Evaluate actual relative to predicted results Commercial Credit Policy
12
Benefits of Stress Testing • More informed strategic decision making • More accurate enterprise risk analysis • Improved risk identification and rating accuracy • Provides assessment of concentration risks, guides risk limits • May impact credit policy decisions • Support ALLL methodology through qualitative factors
Commercial Credit Policy
13
Prudent CRE Loan Workouts
• Interagency Statement updates and replaces 1991 CRE guidance • Promotes supervisory consistency • Addresses risk management elements for loan workout programs, classification of loans, and reporting considerations • Principles also apply to other commercial loans
Commercial Credit Policy
14
Prudent CRE Loan Workouts • Risk Management Elements for Loan Workout Programs – Infrastructure, policies, procedures
• Loan Workout Arrangements – Loan structure, analysis, collateral, guarantees
• Classification of Loans – Performing/non-performing, partial charge-offs, two note split
• Regulatory Reporting and Accounting Considerations – Nonaccrual, ALLL, TDRs
Commercial Credit Policy
15
Appraiser Selection and Engagement Process
• Selection process: – Independent from loan production – Based on Appraiser Competency: • •
Geographic competency Property Type Competency
• Communication with the appraiser – Fine line: preserve independence (lack of pressure); provide information to appraiser in timely fashion
• Engagement letter – Spell out valuation assignment requirements: • • •
Market Value Scope of Work Appraisal Report Type (Good Practice: Self-Contained or Summary)
Commercial Credit Policy
16
Appraisal Review
• Competence of reviewer – Property type expertise – Independence from transaction
• What type of review? – Compliance (with basic regulatory requirements) – Technical (May be Standard 3 Review: USPAP) – Not a “one size fits all”
• If review issues – communicate with appraiser • Document review in Loan File
Commercial Credit Policy
17
Evaluations • Minimum Requirement for three exemption situations: – Threshold: $250,000 transaction value – Evaluation allowed – Business Loan exemption (meeting certain conditions) Evaluation allowed – Subsequent transaction • No New Monies (except reasonable closing costs) – Evaluation is allowed • New Monies – – – –
Deterioration in market conditions – Appraisal required Deterioration in physical aspects of property – Appraisal required Deterioration in both – Appraisal required No Deterioration in either – Evaluation is allowed
Commercial Credit Policy
18
Evaluations • Can be performed in-house or by third party • Person performing Evaluation: – Independent – Competent: Document qualifications and experience level of individuals deemed acceptable for purposes of preparing evaluations, based on: • Training • Experience
– Evaluation must elicit Market Value – Evaluation Contents: spelled out in Interagency Appraisal and Evaluation Guidelines
Commercial Credit Policy
19
Troubled Debt Restructuring
Commercial Credit Policy
20
Troubled Debt Restructuring
Commercial Credit Policy
21
Troubled Debt Restructuring
• A loan modification constitutes a TDR when two conditions are present: – Borrower is experiencing financial difficulty – Creditor grants a concession it would not otherwise consider but for the borrower’s financial difficulties
Commercial Credit Policy
22
Financial Difficulty and Concessions Determining if a borrower is experiencing financial difficulty:
• Default on any debt • Debt service capacity • Deteriorating collateral values (e.g., LTV of CRE project) • Viability & prospects of business/project • Are payments being kept current with an interest reserve?
Determining if a concession has been granted:
• • • • •
Effective borrowing rate Maturity of loan Amortization period Terms as compared to prior debt Terms as compared to other loans with similar risk • Concessions from borrowers
Commercial Credit Policy
23
Multi-Note Split • A troubled loan is formally restructured into two notes: – A portion of the current outstanding debt separated into a new legally enforceable note (i.e., the first note) may be placed back on accrual status in certain situations. • Reasonably assured of repayment according to prudently modified terms • Sustained payment performance for a reasonable time (performance prior to the restructuring may be taken into account) • The portion of the debt that is not reasonably assured of repayment (i.e., the second note) has been charged-off.
• An assessment of the borrower’s financial condition and the prospects for full repayment of the first note should be well-documented
Commercial Credit Policy
24
Commercial OREO as a % of Total Secured CRE Loans
Commercial Credit Policy
25
C&D OREO as a % of C&D Loans
Commercial Credit Policy
26
Non farm, non residential OREO as a % of non farm, non residential loans
Commercial Credit Policy
27
OREO Increase in OREO balances and inability to sell has lead to banks’ desire to exchange OREO assets Common issues associated with the exchange of OREO assets for an equity interest (generally in an LLC) include: • • • • •
The bank’s loss of control over its OREO assets, The exchange of OREO for an asset of questionable liquidity and value, The commingling of the bank’s OREO with other real estate that may be of poorer quality, Significant up-front fees and recurring management fees paid to the organizing company, and Unfavorable priority of payments between the banks and equity investors. Commercial Credit Policy
28
Considerations for OREO Exchanges • • • • • • • • •
Is the exchange permissible and in the best interest of the bank? What is the proper accounting treatment? How will exchange will make the real estate more marketable? Ensure that an accurate & updated value of the exchanged asset is established Ensure adequate risk management, measurement systems, and controls Monitoring to avoid multiple exchanges for interests in any other property Compliance with OCC’s OREO regulation, 12 CFR 34 Conduct adequate due diligence Holding period
Commercial Credit Policy
29
2011 Credit Underwriting Survey
• Findings – Underwriting standards are in transition – Survey showed some signs of easing especially in commercial and industrial products – Many products standards remained unchanged or tightened especially for products with poor performance
Commercial Credit Policy
30
Recent References • OCC 2011-10 - Other Real Estate Owned: Exchanging Other Real Estate Owned for Other Assets • OCC 2010-42 - Sound Practices for Appraisals and Evaluations: Interagency Appraisal and Evaluation Guidelines • OCC 2009-32 – Interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts • OCC 2006-46 - Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices
Commercial Credit Policy
31
Comments or Questions?
32
Commercial Real Estate 2011 Interagency MDI Conference June 15-16, 2011 Darrin Benhart Director - Commercial Credit Policy
Agenda •
CRE Portfolio – Concentration/Volume – Performance
•
Other Issues in Commercial Real Estate – Stress Testing – Interagency Workout Guidance – Appraisals
•
Troubled Debt Restructures – Trends – Financial Distress/Concessions
•
OREO – Trends – Guidance on OREO exchanges
•
Credit Underwriting Survey Commercial Credit Policy
2
Commercial Loan Balances, National Banks, $Bn
Commercial Credit Policy
3
CRE as a % of Capital
Commercial Credit Policy
4
CRE Portfolio Performance -- Nonperforming 10.00% 9.00%
All National Banks
Large Banks
Midsize Banks
Community Banks
20 Yr Ave All National Banks 8.00% 7.66% 7.37% 7.25%
7.00% 6.00%
5.60% 5.00% 4.00% 3.24%
3.00% 2.00% 1.00%
Commercial Credit Policy
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
4Q07
3Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
4Q05
3Q05
2Q05
1Q05
4Q04
3Q04
2Q04
1Q04
4Q03
3Q03
2Q03
1Q03
4Q02
3Q02
2Q02
1Q02
4Q01
0.00%
5
CRE Portfolio Performance – Ann. Net Losses 7.00%
6.00%
All National Banks
Large Banks
Midsize Banks
Community Banks
20 Yr Ave All National Banks
5.00%
4.00%
3.00% 1.60% 1.52% 1.52% 1.38%
2.00%
1.00% 0.71%
1Q11
4Q10
3Q10
2Q10
1Q10
4Q09
3Q09
2Q09
1Q09
4Q08
3Q08
2Q08
1Q08
4Q07
3Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
4Q05
3Q05
2Q05
1Q05
4Q04
3Q04
2Q04
1Q04
4Q03
3Q03
2Q03
1Q03
4Q02
3Q02
2Q02
1Q02
4Q01
0.00%
‐1.00%
Commercial Credit Policy
6
National vacancy rates starting to recover but will improve slowly
Vacancy (%)
Office
Retail Warehouse
Apartment
Forecast
Source: Property & Portfolio Research; 2011Q1 forecast
Commercial Credit Policy
7
Net operating income (NOI) will recover slowly Annual NOI growth
Source: Property & Portfolio Research; 2011Q1 forecast
Commercial Credit Policy
8
Cap rates flat or down slightly across property types
Source: Real Capital Analytics; through March 2011; transaction-based
Commercial Credit Policy
9
Spread Between CRE Cap Rate and 10 Year Treasury
Commercial Credit Policy
10
Property values will recover slowly with prior peaks well out of reach over Property value % of recent peak the next few years
70% 65%
65%
Source: Property & Portfolio Research; 2011Q1 forecast
Commercial Credit Policy
11
Stress Testing • What is stress testing? – Sensitivity Analysis – Portfolio Stress Testing – Enterprise (Macro) Stress Testing
• Approaches – Top Down • Macroeconomic based • Portfolio-wide assumptions
– Bottom Up • Loan level assumptions • “Roll-up” of results • Can tie assumptions to macro scenarios
• Validation – Evaluate actual relative to predicted results Commercial Credit Policy
12
Benefits of Stress Testing • More informed strategic decision making • More accurate enterprise risk analysis • Improved risk identification and rating accuracy • Provides assessment of concentration risks, guides risk limits • May impact credit policy decisions • Support ALLL methodology through qualitative factors
Commercial Credit Policy
13
Prudent CRE Loan Workouts
• Interagency Statement updates and replaces 1991 CRE guidance • Promotes supervisory consistency • Addresses risk management elements for loan workout programs, classification of loans, and reporting considerations • Principles also apply to other commercial loans
Commercial Credit Policy
14
Prudent CRE Loan Workouts • Risk Management Elements for Loan Workout Programs – Infrastructure, policies, procedures
• Loan Workout Arrangements – Loan structure, analysis, collateral, guarantees
• Classification of Loans – Performing/non-performing, partial charge-offs, two note split
• Regulatory Reporting and Accounting Considerations – Nonaccrual, ALLL, TDRs
Commercial Credit Policy
15
Appraiser Selection and Engagement Process
• Selection process: – Independent from loan production – Based on Appraiser Competency: • •
Geographic competency Property Type Competency
• Communication with the appraiser – Fine line: preserve independence (lack of pressure); provide information to appraiser in timely fashion
• Engagement letter – Spell out valuation assignment requirements: • • •
Market Value Scope of Work Appraisal Report Type (Good Practice: Self-Contained or Summary)
Commercial Credit Policy
16
Appraisal Review
• Competence of reviewer – Property type expertise – Independence from transaction
• What type of review? – Compliance (with basic regulatory requirements) – Technical (May be Standard 3 Review: USPAP) – Not a “one size fits all”
• If review issues – communicate with appraiser • Document review in Loan File
Commercial Credit Policy
17
Evaluations • Minimum Requirement for three exemption situations: – Threshold: $250,000 transaction value – Evaluation allowed – Business Loan exemption (meeting certain conditions) Evaluation allowed – Subsequent transaction • No New Monies (except reasonable closing costs) – Evaluation is allowed • New Monies – – – –
Deterioration in market conditions – Appraisal required Deterioration in physical aspects of property – Appraisal required Deterioration in both – Appraisal required No Deterioration in either – Evaluation is allowed
Commercial Credit Policy
18
Evaluations • Can be performed in-house or by third party • Person performing Evaluation: – Independent – Competent: Document qualifications and experience level of individuals deemed acceptable for purposes of preparing evaluations, based on: • Training • Experience
– Evaluation must elicit Market Value – Evaluation Contents: spelled out in Interagency Appraisal and Evaluation Guidelines
Commercial Credit Policy
19
Troubled Debt Restructuring
Commercial Credit Policy
20
Troubled Debt Restructuring
Commercial Credit Policy
21
Troubled Debt Restructuring
• A loan modification constitutes a TDR when two conditions are present: – Borrower is experiencing financial difficulty – Creditor grants a concession it would not otherwise consider but for the borrower’s financial difficulties
Commercial Credit Policy
22
Financial Difficulty and Concessions Determining if a borrower is experiencing financial difficulty:
• Default on any debt • Debt service capacity • Deteriorating collateral values (e.g., LTV of CRE project) • Viability & prospects of business/project • Are payments being kept current with an interest reserve?
Determining if a concession has been granted:
• • • • •
Effective borrowing rate Maturity of loan Amortization period Terms as compared to prior debt Terms as compared to other loans with similar risk • Concessions from borrowers
Commercial Credit Policy
23
Multi-Note Split • A troubled loan is formally restructured into two notes: – A portion of the current outstanding debt separated into a new legally enforceable note (i.e., the first note) may be placed back on accrual status in certain situations. • Reasonably assured of repayment according to prudently modified terms • Sustained payment performance for a reasonable time (performance prior to the restructuring may be taken into account) • The portion of the debt that is not reasonably assured of repayment (i.e., the second note) has been charged-off.
• An assessment of the borrower’s financial condition and the prospects for full repayment of the first note should be well-documented
Commercial Credit Policy
24
Commercial OREO as a % of Total Secured CRE Loans
Commercial Credit Policy
25
C&D OREO as a % of C&D Loans
Commercial Credit Policy
26
Non farm, non residential OREO as a % of non farm, non residential loans
Commercial Credit Policy
27
OREO Increase in OREO balances and inability to sell has lead to banks’ desire to exchange OREO assets Common issues associated with the exchange of OREO assets for an equity interest (generally in an LLC) include: • • • • •
The bank’s loss of control over its OREO assets, The exchange of OREO for an asset of questionable liquidity and value, The commingling of the bank’s OREO with other real estate that may be of poorer quality, Significant up-front fees and recurring management fees paid to the organizing company, and Unfavorable priority of payments between the banks and equity investors. Commercial Credit Policy
28
Considerations for OREO Exchanges • • • • • • • • •
Is the exchange permissible and in the best interest of the bank? What is the proper accounting treatment? How will exchange will make the real estate more marketable? Ensure that an accurate & updated value of the exchanged asset is established Ensure adequate risk management, measurement systems, and controls Monitoring to avoid multiple exchanges for interests in any other property Compliance with OCC’s OREO regulation, 12 CFR 34 Conduct adequate due diligence Holding period
Commercial Credit Policy
29
2011 Credit Underwriting Survey
• Findings – Underwriting standards are in transition – Survey showed some signs of easing especially in commercial and industrial products – Many products standards remained unchanged or tightened especially for products with poor performance
Commercial Credit Policy
30
Recent References • OCC 2011-10 - Other Real Estate Owned: Exchanging Other Real Estate Owned for Other Assets • OCC 2010-42 - Sound Practices for Appraisals and Evaluations: Interagency Appraisal and Evaluation Guidelines • OCC 2009-32 – Interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts • OCC 2006-46 - Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices
Commercial Credit Policy
31
Comments or Questions?
32
