Important Considerations for Banks with High CRE Exposure by Stephen Curry and Jason Pumpelly

Monday, the FDIC issued a new FIL directive targeting institutions with high concentrations in Commercial Real Estate (CRE). Their guidance outlines specific criteria triggering heightened regulatory monitoring, signaling increased scrutiny during the next examination, or possibly sooner. These criteria include the current 100/300 rule and cases where the outstanding balance of the CRE loan portfolio has surged by 50 percent or more in the preceding 36 months. Given the aggressive approach in exams to this point, this is an early warning of even more examination focus and direction in risk, liquidity, credit admin, reserve and capital adequacy. The announcement also unequivocally attributes past asset quality issues and bank failures to CRE lending concentrations coupled with inadequate risk management practices. In previous crises, "a lack of effective management in CRE lending concentrations led to elevated credit losses". Additionally, failed banks relied on funding sources beyond stable deposits and maintained lower levels of capital.

Our view is that banks are on relatively solid footing regarding LTV's. The customary LTV's were 100%+ during the 80's leading up to 1986, and 75-85% LTV's leading up to the Liquidity Crisis of 2008. Post-crisis, LTV's were 60-70%, and in some cases as the cycle got longer, banks pulled back to very conservative 50-60 LTV's. The Fed action of 400+ bps in rate increases has surprised even the savviest bank economists due to the pandemic black swan event of 2020 and the governments' inflationary spending and lockdowns. The spending and supply-chain disruptions along with lockdowns caused much of the inflationary pressure, while the lockdowns produced/helped propel the work-from-home phenomenon and the occupancy deterioration of the office sector. The increase in short-term rates, declines in occupancy and thus revenue, have crushed the DSCR's of otherwise prudent CRE loans. The climb out of some of this distress will be challenging in many cases and flat-out impossible in some cases. Identifying and categorized these loans and the underlying collateral is a critical exercise leading into 2024, with the assistance of a strong advisory team.

FDIC announcement reminds institutions of the critical importance of credit risk, stress testing, liquidity and robust credit management practices. These management practices, in addition to workout preparedness, loan file management, and proactive credit evaluations, should be a top priority at banks with high CRE exposure. As we've seen in the past with bank failures and/or CRE loan workouts/sales, the loan files are often incomplete; the relationship managers haven't enforced timely borrower and property financials, rent rolls, tax returns, and borrower liquidity or even properly monitored these even in good times. When CRE loan portfolio risk increases, as in the present cycle, banks and their portfolio teams and advisors can get ahead of the game by becoming intimately involved in daily performance of the collateral with the intent of reducing exposure and preventing unforeseen deterioration in collateral positions. The FDIC's comment in their announcement is spot on, 'In these crises, when CRE markets deteriorated, poor management of CRE lending concentrations led to increased credit losses.' In cycles like the present there is often an overreaction to construction loan exposure, when the reality, in the case of apartments specifically, is they will always stabilize, it's just a matter of time. It will be less about the market and more about where interest rates are in 12-18 months. When unemployment ticks up, or disruption spreads, our bank clients should be vigilant with their portfolio management and capital and avoid the panic.

Our firm has the skills and capacity to help institutions face these challenges. We have deep expertise in Commercial Real Estate and Banking, and can help with strategy, risk management, liquidity management and workouts. Given the breadth of our activity in the industry, we understand what is needed by the regulators now, and in the future, as the environment evolves.

This presentation is being furnished on a confidential basis to provide preliminary summary information. The information, tools and material (collectively, information) contained herein is not directed to or intended for distribution or use by any person or entity who is a citizen or resident of or located in any jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation or which would subject Endurance Advisory Partners, LLC, to any registration or licensing requirement within such jurisdiction.

The information presented herein is provided for informational purposes only and is not to be used or considered as an offer to sell, or buy securities or other financial instruments, or any advice or recommendation with respect to such securities or other financial instruments. The information may not be reproduced in whole or in part or otherwise made available without the prior written consent of Endurance Advisory Partners, LLC. Information and opinions presented have been obtained or derived from sources believed to be reliable, but Endurance Advisory Partners, LLC makes no representation as to their accuracy or completeness. Endurance Advisory Partners, LLC, accepts no liability for any loss arising from the use of the information contained herein.

This information is subject to periodic update and revision. Materials should only be considered current as of the date of the initial publication, without regard to the date on which you may access the information. Endurance Advisory Partners, LLC, maintains the right to delete or modify the information without prior notice.

Under no circumstances and under no theory of law, tort, contract, strict liability or otherwise, shall Endurance Advisory Partners, LLC be liable to anyone for any damages resulting from access or use of, or inability to access or use, this information regardless of whether they are dire, indirect, special, incidental, or consequential damages of any character, including damages for trading losses or lost profits, or for any claim or demand by any third party, even if Endurance Advisory Partners, LLC knew or had reason to know of the possibility of such damages, claim or demand.