HomeReal Estate NewsCommercialCRE lenders earn higher pre-tax returns, FDIC reports

CRE lenders earn higher pre-tax returns, FDIC reports

More than 98 percent of banks engage in Commercial Real Estate (CRE) lending, while CRE loans are the largest loan portfolio type for almost half of all banks, according to the Federal Deposit Insurance Corporation’s (FDIC) recently released Summer 2022 edition of Supervisory Insights. The report included an article, “Commercial Real Estate: An Update on Bank Lending Amid the Evolving Pandemic Backdrop.” The article examined commercial real estate-focused banks’ performances from the beginning of the COVID-19 pandemic through 2021 as well as “observations related to CRE lending risk management practices.”

Banks provide a significant amount of CRE financing

CRE loans’ dollar volume is at a historic high, and the number of CRE-concentrated banks is increasing. The FDIC noted that while a bank concentrating its lending to a certain sector isn’t an issue, it’s also not 100 percent risk-free. “The majority of banks with CRE loan concentrations are satisfactorily rated,” the article said. “Nevertheless, CRE loan concentrations add dimensions of risk that necessitate continued attention from banks and their regulators, especially as the pandemic lingers and uncertainties remain.”

CRE-concentrated banks’ performance trends

Banks that choose and underwrite risks prudently, oversee portfolios diligently and have safe lending principles, can find CRE lending to be a profitable business line, according to the FDIC. Both CRE lenders and Acquisition, Development, and Construction (ADC) lender groups showed higher pre-tax returns on average assets (ROAA) than all other banks. Both groups still operate with a generally higher risk profile, however.

Meanwhile, CRE-concentrated banks experienced some stress during the COVID-19 pandemic, but did not deal with many loan delinquencies, which were at historically low levels. Aggregate loan losses were also low. The FDIC attributed these trends partly to the available stimulus and relief programs and low borrowing costs. These banks also shielded themselves from loan delinquencies by extensively working with borrowers that encountered stress during the pandemic. Doing so suppressed delinquencies and minimized losses because it gave borrowers more time to address their financial issues.

“Against the backdrop of low delinquencies and a recovering economy, ADC/CRE Banks are outpacing all other banks in terms of pre-tax ROAA,” the article said. “Their medians are 1.57 percent and 1.49 percent, while the median for all other banks is 1.26 percent. The higher returns for the ADC/CRE Banks may reflect, at least in part, the functioning of ‘higher risk, higher reward,’ although many factors complicate the core earnings analysis.”

FDIC’s recommended CRE lending risk management practices

The FDIC continued to assess banks’ CRE lending risk management practices throughout the COVID-19 pandemic. The organization noted that banks “with comprehensive, well-developed risk management practices generally adapted better during the pandemic.” Meanwhile, banks heavily involved in CRE lending had robust contingency planning and stress testing/scenario analysis processes in place also fared well during the pandemic.

However, the FDIC noted places where banks could improve on their CRE lending risk management, including underwriting. “Assessing repayment capacity is one of the more common credit underwriting concerns that examiners have reported through supervisory recommendations,” the FDIC said. “The pandemic has complicated repayment capacity analyses. For example, considerations include when and how to consider PPP loan funds, stimulus funds, or other relief-driven support.”

The FDIC recommended banks collect the most relevant projections available and consider if and how the borrower’s business is expected to rebound and replace the interim support measures. Additionally, examiners have observed other instances of outdated financial information and unsupported projections underpinning repayment capacity analyses.

“Continued uncertainties surrounding economic forecasts combined with varying pandemic impacts by sector and geography also present bankers and appraisers with challenges in developing well-supported and timely collateral valuations for CRE properties,” the FDIC said.

CRE lenders also could tighten up their risk management regarding management information systems, market analysis, stress testing and credit risk rating systems.

“CRE lending remains an important aspect of bankers’ efforts to support their communities, including in response to the still-evolving impacts of the COVID-19 pandemic,” the FDIC said. “The FDIC recognizes these efforts, when prudently undertaken and consistent with safe and sound banking practices, serve the public interest. As a result, the FDIC continues to encourage and support banks in taking prudent steps to assist affected customers. Examining the effectiveness of governance and risk management practices related to CRE lending will remain a supervisory priority.”

Download the full FDIC Summer 2022 Supervisory Insights report here.

 

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