WASHINGTON - Acknowledging that regulatory guidance to limit banks' concentration in commercial real estate has failed, Comptroller of the Currency John Dugan said Friday that the banking agencies will issue new, tougher standards.
Regulators are weighing several options, he said, including tougher concentration caps, increased capital requirements, minimum underwriting standards and limits on banks that use wholesale funding to finance these loans.
"We need to revisit the issue of the appropriate regulatory response to CRE lending concentrations, especially for construction and development lending, and especially for concentrations supported by noncore funding," Dugan told the Independent Community Bankers of America conference in Orlando. "While the concentration guidance we issued in 2006 was necessary — even though it was opposed by many parts of the industry — in retrospect, it has obviously not worked as well as we would have liked."
Regulators issued guidance four years ago advising banks to limit their concentration in CRE loans to 300% of total capital and concentrations in land, land development and construction loans to 100% of capital.
But trouble in the CRE sector has continued to dog community banks, and has emerged as a leading cause of failures. CRE loans account for more than one-third of the loan book at the average community bank and about half the loans at banks with $500 million to $2 billion of assets, Dugan said.
"We know that significant CRE concentrations in economic downturns can lead to an increase in problem banks, an increase in bank failures, loss of jobs, loss of incomes, loss to communities, loss to the deposit insurance fund and higher costs for all banks, even those that do not have CRE concentrations," Dugan said.
Though nearly 80% of small national banks have Camels ratings of 1 or 2, a growing minority have lower ratings, and nearly 9% of all insured depository institutions were problem banks at Dec. 31, Dugan said.
He singled out newly chartered banks as potential sources of trouble, calling for minimum federal standards for any de novo that has significant CRE concentrations or relies on noncore deposits for an extended period.
After his speech, many community bankers acknowledged that CRE remains a problem and voiced support for some additional limitations.
Underwriting standards should be tougher, for example, said Daniel P. Reininga, the chief operating officer and executive vice president of Lake Shore Savings in Dunkirk, N.Y. Too many banks have "gotten greedy," he said.
"Without the greed factor, we're probably OK," he said. "But it's probably time to toughen up the rules. But within reason. I wouldn't want to see them go too far in the other direction, either. You need that balance."
David Mancuso, the chief executive of Lake Shore Savings, agreed that "it all gets back to underwriting." "You have to toughen underwriting standards now," he said.
Russell Laffitte, the president of the $460 million-asset Palmetto State Bank in Hampton, S.C., said CRE has proven too tempting for some institutions.
"Commercial real estate loans are easy loans, which is why people make them. But when they go bad, they go real bad," he said.
Joe Vondra, the CEO of $250 million-asset River State Bank in Warren, Ill., said Dugan's "tough medicine speech" was warranted.
"We've been down this road before with commercial real estate," he said. "This was a bit of a wake-up call."
Also speaking at the conference, Federal Deposit Insurance Corp. Chairman Sheila Bair weighed in on another hot topic, arguing that a bill offered by Senate Banking Committee Chairman Chris Dodd would not resolve the "too big to fail" problem. She criticized a provision that would let the Federal Reserve Board exercise its emergency lending authority to help a faltering financial firm.
"We do have serious concerns about other sections of the Senate draft, which seem to allow the potential for back-door bailouts through the Federal Reserve Board's 13(3) authority," she said. Bair later issued a statement saying that Senate leaders were responding to this concern. "Sen. Dodd assures me these provisions will be removed," she said.
She also clarified a rule that caps deposit rates for certain banks but gives relief to some in "high-rate" areas. Observers have said that a large bank could skew a "high-rate" determination if it has multiple branches in an area. "It was never our intent for this regulation to disadvantage smaller banks," Bair said, adding that the FDIC "will, as appropriate, drop multiple branches of the same banks from the calculation."