Commercial Real Estate (CRE) – Risks and Effective Risk ... · PDF fileCommercial Real Estate (CRE) – Risks and Effective Risk ... CoStar Portfolio ... Asheville Boston Lebanon

Commercial Real Estate (CRE) –Risks and Effective Risk Management

July 21, 2016 New York Region Industry Teleconference

FEDERAL DEPOSIT INSURANCE CORPORATION

Nationwide, CRE Trends are Positive with Some Signs of Emerging Risk

CRE market conditions continue to improve

CRE lending has increased, but concentrations are below those of the bubble years

The multifamily market has seen a lot of construction and some areas may be approaching oversupply

Loan underwriting standards have relaxed, which may continue as competition increases

2Note: Information and comments are the opinion of the author, not the FDIC. This presentation and comments are not for attribution, quotation, or distribution.


CRE Concentrations are High in Several Areas of the Country

Source: FDIC.Note: Data as of March 31, 2016.

Nation 176%

Median CRE Concentration

0-100%100 – 176%176 – 300%> 300%



CRE Past-Due Rates are Higher Than the Nation in Many Eastern States

Source: FDIC.Note: Data as of March 31, 2016.

Median CRE Past Dues

0-0.5%.5 – 0.76%.76 – 1.5%> 1.5%

Nation 0.76%



Foreign Capital Flows in U.S. CRE

0

20

40

60

80

100

120

Latin America Australia

Mid-East & Africa Asia

Canada Europe

$ Billions

Strong Inflows from Abroad Continue

Source: Real Capital Analytics. Updated June 23, 2016.



Valuation Pressures are Increasing

Commercial property values have recently exceeded pre-crisis peaks Despite positive rent growth, net operating income has not kept pace with price

appreciation, pushing capitalization rates below pre-crisis troughs

0

20

40

60

80

100

120

140

160

1Q00

1Q02

1Q04

1Q06

1Q08

1Q10

1Q12

1Q14

1Q16

Retail Office Industrial ApartmentSource: CoStar Portfolio Strategies, data are as of First Quarter 2016. Constant quality price index, 4Q08 = 100.

CRE Prices

0

2

4

6

8

10

12

1Q00

1Q02

1Q04

1Q06

1Q08

1Q10

1Q12

1Q14

1Q16

Retail Office Industrial Apartment

Source: CoStar Portfolio Strategies, data are as of First Quarter 2016.

Capitalization Rates



0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0

2

4

6

8

10

12

14

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Multifamily (Apartment)OfficeRetailIndustrial

Actual ForecastVacancy Rate (Percent)

Recession

CRE Vacancy Rates are Improving but Multifamily May Face Some Weakness Ahead

Source: CoStar Portfolio Strategies. Data as of March 31, 2016.



Price Appreciation is Expected to Ease

Source: CoStar Portfolio Strategies. Data as of March 31, 2016.Note: Price growth is based on CoStar constant quality sales index.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

-25

-20

-15

-10

-5

0

5

10

15

20

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Multifamily (Apartment)OfficeRetailIndustrial

Actual ForecastPrice Growth, Year-over-year percent

Recession



Who Holds Multifamily Loans?

Source: Federal Reserve Board, Flow of Funds Z.1, Table L219, June 9, 2016.Note: Data as of March 31, 2016.

Total $ in BillionsDebt Outstanding by Holders of Credit Risk

9

Government Sponsored Enterprises (GSEs)$47343%

Banks and Thrifts$38935%

State and Local CreditAgencies

$958%

Other$373%

LifeInsuranceCompanies

$636%

CMBSIssuers$575%

Note: Information and comments are the opinion of the author, not the FDIC. This presentation and comments are not for attribution, quotation, or distribution.


Multifamily Property Supply has been Expanding Rapidly

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1Q02 3Q05 1Q09 3Q12 1Q16

Four-Quarter Completions as a Share of Inventory (Percent)

Source: CoStar Portfolio Strategies. Note: Four-quarter completions are the sum of the most recent four quarters' completions as a share of the inventory one year earlier.

Multifamily (Apartment)

Industrial

Retail

Office

Recession

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1Q11 1Q12 1Q13 1Q14 1Q15 1Q16

Units Under Construction as a Share of Inventory (Percent)

Source: CoStar Portfolio Strategies. Note: Units under construction are those due to be completed within six quarters.


Industrial

Retail

Office



New York Region Multifamily Supply is Also Increasing

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1Q02 3Q05 1Q09 3Q12 1Q16

Four-Quarter Completions as a Share of Inventory (Percent)

Source: CoStar Portfolio Strategies. Note: Four-quarter completions are the sum of the most recent four quarters' completions as a share of the inventory one year earlier.


Industrial

Retail

Office

Recession0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1Q11 1Q12 1Q13 1Q14 1Q15 1Q16

Units Under Construction as a Share of Inventory (Percent)

Source: CoStar Portfolio Strategies. Note: Units under construction are those due to be completed within six quarters.


Industrial

Retail

Office



New Multifamily Units Underway Exceed Absorption

0

2

4

6

-0.5

0.0

0.5

1.0

1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17

Absorption/Stock (%, Left Scale)Completions/Stock (%, Left Scale)Vacancy Rate (%, Right Scale)

Actual Forecast

Source: CoStar Portfolio Strategies, first quarter 2016. Data represent the 54 largest markets nationwide.



Additions to Existing Multifamily Stock are Very Large for Some Metro Areas

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Multifamily Units Under Construction as a Share of Inventory, Percent

Source: CoStar Portfolio Strategies. Data are as of first quarter 2016.

Burlington, NCProvo, UTNashville, TNFort Myers, FLMcAllen, TXCharlotte, NCCorpus Christi, TX



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Units Under Construction as a Share of Inventory, Percent

Source: CoStar Portfolio Strategies. Data are as of first quarter, 2016.

Several Metro Areas in the New York Region are Also Adding Multifamily Stock



50

70

90

110

130

150

170

190

210

230

60

61

62

63

64

65

66

67

68

69

70

Homeownership Rate (L)

Housing Affordability Index (R)

US Homeownership

Source: Census Bureau, National Association of Realtors, Haver Analytics.

Ownership Rate Housing Affordability Index

80

90

100

110

120

130

140

150

1-4 Family Multifamily Residential

Loan Growth By Type

Source: Federal Reserve Board, Haver Analytics.

Index (2007=100)

Increases in Multifamily Reflect a Decline in Homeownership Rates and Affordability



Looking Ahead: CRE Issues to Watch

Rising interest rates may put pressure on CRE debt service and capitalization rates

Multifamily might be approaching the supply/demand equilibrium point in some areas –suggesting that prices may weaken and vacancy rates may rise Underwriting standards may continue to relax with increased competition



CRE Risk Management Discussion Topics

Overview of existing and recent applicable regulatory guidance

Commonly identified risk management weaknesses

Stress testing/Sensitivity analysis

17


FDIC Rules and Regulations Part 365 –Real Estate Lending Standards

Provides regulatory guidelines and expectations regarding:• Lending Standards and Policies• Risk Management• Governance• Maximum Loan‐to‐Values• Internal Reporting

18


FDIC Rules and Regulations – Part 365Appendix A of Subpart A

Real estate policies should include:• Geographic areas in which the bank will lend• Diversification standards and limits by type and geographic market

• Prudent underwriting standards and exception monitoring

• Regular portfolio monitoring and timely reports to the Board

• Consideration of the need to avoid undue concentrations of risk

• Regular monitoring of market conditions

19


December 5, 2006 Interagency Guidance

Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices

Frequently Asked Questions for CRE Concentration Guidance

• Identifies concerns with rising CRE concentrations• Provides an overview of regulatory expectations:

– Ongoing risk assessments– Effective risk management framework

20


Effective Risk Management Framework

Board and Management Oversight Portfolio Management Management Information Systems Market Analysis Credit Underwriting Standards Portfolio Stress Testing and Sensitivity Analysis Credit Review

21


Examples of Effective Risk Management

Adopt adequate policies, underwriting standards, risk management practices, and concentration limits

Develop appropriate lending, capital, and ALLL strategies Analyze global cash flows based on reasonable information Analyze markets and scenarios to quantify potential risk Implement management and Board reporting of strategies

and policies Analyze repayment capacity over the life of the loan Monitor supply/demand Conduct sufficient ongoing reporting to identify, measure,

monitor and manage concentration risk Perform appraisal reviews to ensure appropriate support

22


December 18, 2015 FDIC Financial Institution Letter (FIL-62-2015)

Statement on Prudent Risk Management for CRE Lending• Concerns with weak risk management practices, high CRE exposures, and easing of underwriting standards

• Reinforces the need to maintain underwriting discipline and ensure prudent risk management practices to manage CRE lending risks

• Examiners will focus on the implementation of activities that identify, measure, monitor, and manage CRE concentration risks

23


December 18, 2015 FDIC Financial Institution Letter (FIL-62-2015) (Continued)

• “In particular, the agencies will focus on those financial institutions that have recently experienced, or whose lending strategy plans for, substantial growth in CRE lending activity, or that operate in markets or loan segments with increasing growth or risk fundamentals.”

• Institutions with inadequate risk management practices may be asked to:• Develop improved practices,• Reduce risk tolerances in underwriting standards, and/or

• Raise addition capital to mitigate CRE risks.

24


Most Commonly Identified CRE Risk Management Weaknesses

Absence of or Inadequate/Excessive Limits Inadequate Underwriting Activities/Loan Policy Exception Programs Lack of or Insufficient Stress Testing Inadequate Concentration Reporting/Board Documentation Inadequate Independence/Expertise of Appraisal Review Programs Insufficient Internal Loan Review of CRE Activities

25


Most Commonly Identified CRE Risk Management Weaknesses (Continued)

Inadequate Consideration of CRE or Lack of Appropriate Independence in ALLL analysis Outdated Market Analysis/Inconsistent with Strategic Plans Ineffective Construction Loan Oversight Lack of Appropriate CRE Contingency Plans

26


Risk Management Cycle

27

Risk Identification

Risk Assessment

Risk Mitigation/ Controls

Ongoing Reporting/ Monitoring


CRE Stress Testing – 2006 Interagency Guidance

Key risk management elements include management information systems, market analysis, and stress testing.

The level of sophistication will depend upon the size and complexity of the institution.

Portfolio stress testing does not require the use of sophisticated portfolio models. Stress testing may be as simple as analyzing the potential effect of stressed loss rates on the bank’s CRE portfolio, capital, and earnings.

28


Stress Testing Steps Commonly Used By FDIC-Supervised Banks

Portfolio Analysis/Segmenting

• Property Type • Industry • Purpose• Ownership/Operation• Location• Repayment Sources• Internal Risk Ratings• Loan Structure

29


Stress Testing Steps Commonly Used By FDIC-Supervised Banks (Continued)

Market Analysis

• Published Research Data• Real Estate Appraisers and Agents• Property Taxing Authority• Local Contractors/Builders/Investors• Community Development Groups

30



Select Most Appropriate Variable(s)

• Sales Prices • Vacancy/Occupancy Rates • Interest Rates• Changes to Zoning/Regulatory/Consumer Preferences

Determine Variable Change/Develop Scenario(s)

Measure Impact of Variable Change(s), Report Results, Review Findings

31



Take Action(s), Such As:

• Continue As Is• Reduce Exposure • Enhance Monitoring and Reporting• Revisit Current Risk Tolerances• Increase ALLL, Capital, and Liquidity Levels• Review CRE Contingency Plan, Strategic Plan, etc.

32


Stress Testing Steps – Example Overview

Conduct Portfolio Analysis/Segmenting• Non‐owner Occupied Commercial Office Buildings

Perform Market Analysis• Market Rents Stable and Vacancy Rates Expected to Increase

Select Most Appropriate Variable• Vacancy Rates

Determine Variable Change/Scenario• Most Likely and Downside Scenarios

Measure Impact, Report Results, Review Findings• Downside Scenario Revealed Significant Risks

Take Action• Maintain Exposure, Revise Plans, and Revisit in 6 Months

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Questions?

34


Contact Information

DIR Regional Manager Cameron [email protected]

RMS Senior Examiner Gregory [email protected]

NY Region Regulatory [email protected]

Event Web Link: https://www.fdic.gov/news/conferences/NY/2016-07-21.html

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Commercial Real Estate (CRE) – Risks and Effective Risk ... · PDF fileCommercial Real Estate (CRE) – Risks and Effective Risk ... CoStar Portfolio ... Asheville Boston Lebanon