Community Bank Council and Regulators Examine the Rising-Interest-Rate Environment

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The economic recovery, is indeed under way agreed members of RMA's Community Bank Council and industry regulators during their annual meeting in Washington last May. The regulators and Council members concurred that the industry, performed remarkably well through this cycle, much more so than in previous cycles. (The minutes from the Community Bank Council Meeting are posted on RMA's Web site, Click on Community Banks, then on Community Bank Council.) Attention is now, focused on the impact of a rising-interest-rate environment on key parts of banks' portfolios, including commercial real estate, the consumer, and sub-prime borrowers.

In an RMA audioconference in June, Tim Long, deputy comptroller for mid-size and community banks at the OCC, and John Lane, deputy director of supervision and consumer protection at the FDIC, discussed several regulatory concerns.

Commercial Real Estate Concentrations

Concentrations in commercial real estate portfolios are a focus for regulators. "We see a problem with some of the data when we look at Call Reports," said Lane. "We've identified 13 markets--six in the Atlanta region, five in the San Francisco region, and one each in the Chicago and Dallas regions--with high concentrations and economic data that would indicate a slowdown may be in progress.

"We're concerned that the commercial real estate portfolios in those areas not be based on favorable views from two years ago. For example, in the Seattle area, which is home to the airline industry, the economic outlook is not as rosy as it once was and yet there is continued growth in construction 0lending."

Although the Florida and Atlanta regions have considerable tourism and retirement inflows, their employment growth rates are among the worst in the country. There has been considerable construction in those areas as well. "We're concerned that the banking sector not get too exposed in these markets," said Lane.

He noted, however, that the FDIC was "pleasantly surprised" when it reviewed Atlanta institutions with the greatest concentrations and investigated the numbers on the Call Report. "Over 50% of the commercial real estate loans were to owner-occupied businesses," he said. "These loans had more than just a single source of repayment based on the collateral value of the underlying real estate. They also had the income of the business. We get some additional comfort in knowing that there's a source of repayment other than the property," he said.

"We were also pleasantly surprised by the very sound underwriting that was present in loans where the owner of the property had invested a good amount of equity. The underwriting was solid and repayment was not an issue."

Lane is not concerned about the effect of rising interest rates on the loans, many of which are variable-rate and were underwritten when interest rates were at 45-year lows. "Since these are primarily owner-occupied businesses, the economic activity that would lead to an increasing interest-rate environment would also be favorable for the businesses that occupy those properties," he said.

"When our review indicates that management has overly concentrated in commercial real estate that is non-owner-occupied, more speculative in nature, and subject to a drop in the borrower's financial standing, we'll want management to start aggressive programs to control and monitor those concentrations," said Lane.

The OCC's experience with commercial real estate portfolios is similar to the FDIC's findings. The OCC, which examined commercial real estate concentrations during a horizontal review of its mid-size banks ($5-25 billion) and community banks, found the real estate portfolios to be largely sound.

"We see some issues in policy, underwriting, exceptions reporting, and stress testing, but we don't see anything approaching the issues that we had in the late 1980s and early 1990s," said Long. …