Commercial Real Estate (CRE): Expanded Regulatory Focus

KPMG Regulatory Insights

• CRE – Ties to Credit, Liquidity & Capital: A growing focus on financial institutions’ management of CRE challenges, particularly to credit, liquidity and capital financial risks.
• CRE Risk Management:  Expectation for heightened CRE risk management (e.g., maintaining strong capital levels, diversifying funding sources, and leveraging stress tests).
• Potential CRE Distress and Modifications: Recognition of potential CRE distress (e.g., due to elevated interest rates, shifting occupancy levels, etc.) and need for transactional modifications and strategic corporate change.

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January 2024

Recent reports and guidance showcase regulators’ continued focus on the potential impacts of challenges in the commercial real estate (CRE) sector on financial institutions, and include:

• Interagency Policy Statement on Prudent CRE Loan Accommodations and Workouts
• Federal Deposit Insurance Corporation (FDIC): Financial Institution Letter on managing CRE concentrations
• Federal Reserve Board (FRB): Fall 2023 Supervision and Regulation Report
• National Bureau of Economic Research (NBER): Working Paper: Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility

The releases are outlined in detail below.

Interagency Policy Statement. In June 2023, the FRB, FDIC, Office of the Comptroller of the Currency (OCC), and the National Credit Union Administration (NCUA), in consultation with state bank and credit union regulators, released a final policy statement updating guidance on CRE loan accommodations and workouts, including risk management, loan classification, regulatory reporting, and accounting considerations on estimating loan losses.

FDIC Financial Institution Letter. The FDIC’s recent Financial Institution Letter focuses on bank management of CRE concentrations in light of “the challenging economic environment,” influenced by the aftermath of the COVID-19 pandemic, rising interest rates, and an inverted yield curve.

The advisory highlights six (6) key risk management practices for banks:

The advisory also encourages banks to:

• Analyze the collectability of their exposures periodically.
• Establish diverse funding sources.
• Maintain strong risk rating systems.
• Effectively manage interest reserves and loan accommodations.
• Leverage stress tests to quantify the impact of changing loan-level fundamentals and economic conditions.

(NOTE: In March 2022, the OCC published a revised version of the "Commercial Real Estate Lending" booklet of the Comptroller's Handbook, discussing risks and risk management practices associated with commercial real estate. The updates provide supervisory guidance for sound risk management practices for CRE, as well as a framework for examiners’ evaluation of banks’ commercial real estate lending activities.)

FRB Supervision and Regulation Report. The FRB’s Fall 2023 Supervision and Regulation Report highlights its assessment of banking system conditions, as well as regulatory and supervisory developments in 2023 and priorities for 2024 (for more information on the report, see KPMG’s Regulatory Alert, here). In its report, FRB notes the following related to CRE:

• “While the banking system is generally sound”, delinquencies for CRE loans increased from low levels in the first half of 2023, with the largest firms experiencing the most substantial increases in delinquency rates, particularly within the office loan segment. In response, many banks have increased their credit loss provisions.
• FRB continues to monitor potential credit deterioration, particularly in the CRE lending segment, including internal loan risk rating accuracy, steps taken to mitigate the risk of loss, and risk reporting to boards of directors and senior management.

NBER Working Paper. NBER’s working paper analyzes the effects of credit risk on the solvency of U.S. banks in a rising interest rate environment with a focus on CRE loans, which are estimated to account for approximately 25 percent of assets for the average bank and almost $2.7 trillion of bank assets in aggregate.

The paper notes several findings in light of recent declines in property values (following higher interest rates) and adoption of hybrid working patterns:

• Approximately 14 percent of all loans and 44 percent of office loans appear to be in "negative equity," meaning that current property values are less than the outstanding loan balances.
• Approximately 33 percent of all loans and the majority of office loans may face “substantial cash flow problems and refinancing challenges”.