Commercial Real Estate: Examination Considerations

It is no secret that commercial real estate (CRE) has bubbled up to the top of most lists of key risks facing the banking industry. Rising interest rates and the lingering impact of a three-year pandemic have elevated the level of uncertainty with regards to property values and borrower debt service capacity.  Financial reporting evidence shows that many banks are pulling back from CRE lending, reducing refinancing opportunities. Also, the impact on different property types and geographic markets does not appear to be consistent, adding to the complexity.

Coming in September, Ask the Regulators will conduct a webinar on the latest guidance, SR Letter 23-5: Prudent Commercial Real Estate Loan Accommodations and Workouts, which was released in July 2023. This guidance updates previous guidance on Commercial Real Estate workouts, and also reinforces that financial institutions should work with creditworthy commercial borrowers who may be experiencing financial difficulties. With the new guidance in place, examiners remain focused on how institutions are monitoring and managing these risks. While not exhaustive, the following list provides your institution a good idea of the commercial real estate portion of the examination focus:

• Repricing risk – Looking at maturity schedules, when will loans reprice with significantly higher rates? Can borrowers withstand the increase in payments? If not, what is the bank doing to mitigate the risk? Can the borrower “right-size” the loan?
• Lease terms and tenant behaviors – Does the bank know when leases mature for material tenants? This is especially critical for single-tenant properties.
• Property classes – What is the breakdown of the bank’s portfolio? Class A property values appear to be holding up better than B and C properties.
• Capitalization (Cap) rates – How closely is management monitoring cap rate trends? What is the impact on LTVs? Cap rates are rising more rapidly for certain property types — senior living is a good example.
• Appraisal review – Is management applying an appropriate level of scrutiny to key appraisal data, such as net operating income and capitalization rates?
• Stress testing and risk to capital – Depth and sophistication of scenario analysis should be commensurate with risk. How do stress testing results feed into capital and strategic planning activities?

Institutions that successfully navigate these choppy waters will be those that effectively gather and digest data from external sources, such as real estate data firms, communication with their borrowers and their own market knowledge. How well the information is synthesized coupled with agile strategic decision-making will be paramount.

Additional supervisory regulatory letters regarding commercial real estate include SR Letter 07-1: Interagency Guidance on Concentrations in Commercial Real Estate, and SR Letter 15-17: Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending. If you have a question related to commercial real estate or your upcoming examination, please reach out to your supervisory relationship team or contact us.