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CEIS Review Q2 2016


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In this Quarterly release Joseph Hill shares his thoughts on relationship lending, community bank CRE growth, and the competitive edge of truly understanding a Borrower’s business. We then would like to introduce Mr. Dean Morgan as CEIS’ Regional Executive for Tennessee and the nearby Southern States, and lastly, leave with an excellent article on tackling Risk Management of a Commercial Real Estate Concentration.

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CEIS Review Q2 2016

  2. 2. ON MY MIND – CEIS PRESIDENT, JOE HILL  With the current healthy lending environment  Banks are actively booking CRE  At some organizations they are increasing C&I transactions to grow their portfolios  Competition for quality borrowers is stiff  The community banking community is not only competing against each other but also against the larger banks or nonbanking organizations  These professional capabilities, below, have long since been the differentiator and competitive edge in dealing with competition  Relationship lending  Knowing the business of the borrower  Personal attention provided to borrowers  Causes of the competitive market  Easing of credit quality requirements  Concessions in pricing, structure and overall terms  Loan and credit trends as well transactional levels should be tracked so the need for reconsideration in policies and practices can be identified
  3. 3. INDUSTRY EVENTS  Recent releases which pertain to our clients  New Off-Site Loan Review Options with the Federal Reserve fir Community Banks with les than $50 Billion in Total Assets  New MBL Rule Could Open up More Niche Lending  House Passes ICBA – Advocated Bill Improving Community Banks Access to Capital  Guidance for Banks’ Maintenance of Records, Record Retention & Examiner Access
  4. 4. IN THE SPOTLIGHT – DEAN MORGAN Regional Executive  Business Development  Engagement Management throughout the Southern Region of the US Banking History/Past Titles  25 years of senior and executive level banking  Senior Loan Officer SVP- Corporate Banking and President & CEO
  5. 5. COMMERCIAL REAL ESTATE: CONCENTRATION RISK MANAGEMENT  The risks posed by concentrations of credit risk in general, and Commercial Real Estate concentrations in particular, have long been an area of focus for bank regulators.  FFIEC expectations for a risk management to manage the risk associated with Commercial Real Estate (CRE) concentrations:  2006 Interagency Guidance: Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices  Statement on Prudent Risk Management for Commercial Real Estate Lending  The remainder of this presentation will provide a high level summary of the 2006 regulatory guidelines and to review current areas of examination focus.
  6. 6. THE 2006 INTERAGENCY GUIDANCE  The 2006 Guidance notes that the CRE sector is vulnerable to business cycle  Banks need to have appropriate risk management practices in place and adequate capital to manage through these cycles  Key elements of risk management include:  Identification of concentrations  Board/management oversight  Active portfolio management  Management information systems  Market analysis  Underwriting standards  Stress testing/sensitivity analysis  Credit risk review  In summary, the Guidance noted that “regardless of its size, an institution should be able to identify and monitor CRE concentrations and the potential effect that changes in market conditions may have on the institution.”
  7. 7. IDENTIFICATION OF CONCENTRATIONS  Regulators have established two thresholds that will assist them in determining the level of a bank’s CRE concentration risk  Construction, land development & other land = 100% of risk-based capital  Commercial Real Estate = 300% of risk based capital and the concentration has increased by 50% or more in the last 3 years  This category includes properties where 50% or more of cash flow is from third parties or where bank depends on sale of the property or permanent financing for repayment  The thresholds are intended to be benchmarks, above which the regulators would expect to see components of the risk management framework outlined in the Guidance  Banks are not exempt from supervision just because they are under these benchmarks  Different types of real estate carry different risks. Banks need segment portfolios by stratifying the portfolio by risk characteristics and by sensitivity to economic, financial or business developments in order to be able to measure and manage risk
  8. 8. BOARD AND MANAGEMENT OVERSIGHT + MANAGEMENT INFORMATION SYSTEMS  Management and the Board should involved in the process  Establish policy guidelines and lending strategy for CRE lending  Require management to implement procedures and controls that will ensure adherence to the Banks overall policies  Use this information determine whether the Bank’s strategies and policies (including limits and sub-limits) remain appropriate in light of current market conditions.  Banks will need adequate management information systems to monitor CRE risk  The MIS must report necessary information  The MIS must be reviewed from time to time to make sure it remains adequate  The MIS must provide the means of reviewing both current data and the extent to which measurements have changed over time, including risk rating migration.
  9. 9. MARKET ANALYSIS  The regulators note that “the important objective is that an institution should have the information necessary to assess the potential effect of market changes on its CRE portfolio and lending strategy.”  Banks should be able “demonstrate that it has an understanding of the economic and business factors influencing its lending markets”  Market risks the 2006 Guidance focuses on specifically:  Demand  Changes in cap rates  Vacancy Rates  Rents  Banks need to be able to identify these risks within their loan portfolios and continually adjust accordingly
  10. 10. CREDIT UNDERWRITING  Clear underwriting policies are necessary if a Bank wants to appropriately manage the risk in their portfolios  Internal factors underwriting policies should address:  Historical experience  Staff Capabilities  Technological Resources  External factors underwriting policies should address:  Market position  The bank’s existing/future trade area  Trends in lending and funding  Analysis should address the overall financial condition of the borrower as well as focusing on the specific project.  RE construction loans,  Controls should be in place to make sure equity is contributed and maintained  A process that documents construction progress, track pre-sale/pre- leasing and exception monitoring and reporting should be implemented
  11. 11. CREDIT UNDERWRITING CONT.  Policies should establish maximum exposure by  Type of property and appropriate loan terms  Pricing and LTV  Requirements for feasibility studies and/or sensitivity/stress testing  Minimum hard equity contribution from the borrower  Minimum borrower net worth  Cash flow and debt service coverage  Collateral valuation  Policies need exception-handling procedures  Exceptions should be infrequent  When an exception is necessary, they should be reported to the Board and Senior management  This report should include trends in the frequency of exceptions and how many underwritings have these exceptions in place
  12. 12. STRESS TESTING/SENSITIVITY ANALYSIS + PORTFOLIO MANAGEMENT  Banks with CRE levels in excess of the regulatory thresholds are expected to analyze the impact of changes in market conditions or interest rates on the portfolio  It should focus on the overall effects of changing market conditions and their impact on asset quality, capital and earnings  Analysis of capital levels in stressed scenarios can provide significant support for justifying CRE concentration, or for supporting increases in such a concentration.  Regulators look for these characteristics in the testing strategies:  Adjustments in credit risk ratings  Contingency plans to limit or reduce exposure  The use of derivatives
  13. 13. EXPLAINING THE DECEMBER 2015 STATEMENT  This statement draws attention to:  Growth in CRE portfolios  Declining CAP rates  Rising property values  The lack of negative signals from vacancy and absorption rates and levels of non-performing loans and charge offs  Banks who complied with these regulations, were able to succeed during the downturn in 2007-2010:  Adequate policies, underwriting standards, credit risk management standards, and concentration limits set at board level, lending strategies and monitoring of same, and strategies to ensure capital/ALLL adequacy appropriate to portfolio risk  Preparation of borrower’s global cash flow analysis based on reasonable rents, sales projections and expenses  Performance of periodic market and scenario analyses of CRE portfolio  Provision of appropriate periodic information to the Board for the latter to assess ongoing appropriateness of strategy and policies  Assessment of ability of borrower to P&I/m when IO converts to payout/absorb impact of rising interest rates  Implementation of procedures for monitoring potential volatility in supply/demand for/of lot, retail/office space and MF units  Implementation of systems which give management and the board sufficient information to identify, measure, monitor and manage concentration risk.  Appraisal review process to ensuring adequate information to support market value conclusion
  14. 14. CURRENT AREAS OF SUPERVISORY FOCUS  Regulators look to focus on banks with CRE portfolios that have grown quickly, banks with CRE portfolios that include high risk segments, and/or banks whose CRE portfolios are approaching or have passed the regulatory thresholds.  When assessing risk, regulators will focus on:  Diversification  Geographic dispersion  Underwriting standards  Guarantees  Level of pre-sale/pre-lease or other identified take out  Portfolio liquidity  Current market conditions  The quality of recent new/ renewed underwriting  Senior management’s and the Board’s efforts to monitor trends
  15. 15. CONCLUSION  Banks with significant growth in CRE and which either currently exceed the regulatory benchmarks for a CRE concentration, or which are likely to exceed these levels in the near future, are encouraged to review their policies and processes to ensure that their risk management framework includes the components outlined in the 2006 and 2016 regulatory publications.  Contact CEIS to discuss your options  Phone #: 888-967-7380