Get Ready for Tough Concentration Questions at your Next Bank Exam

No matter the regulator, community banks with concentration issues should expect extra scrutiny at their next exam. Banks without proper concentration risk management processes are in danger of CAMELS downgrades, enforcement action, or supervisory feedback that requires board participation.

The Federal Reserve is the latest prudential regulator to warn community and regional banks that supervisors are paying attention to concentrations, particularly those in commercial real estate. “Reflecting increased credit risk concerns, the Federal Reserve has enhanced procedures for monitoring credit concentrations, including CRE loans,” the Federal Reserve said its November 2022 Supervision and Regulation Report.

The Office of the Comptroller of the Currency revealed in October that it would be heightening its focus on banks with concentrations. And the Federal Deposit Insurance Corp. in early August put community banks on notice that its safety and soundness examiners would also be monitoring banks with high concentrations. The FDIC said that its examiners had found problems with portfolio and loan-level data quantity and quality, improper metrics, inadequate stress tests built on faulty assumptions, and a failure to assess market conditions.

Concentrations are increasing

As the Fed noted, as of June 30, about 28 percent of insured banks reported a CRE concentration. Although lower than during the financial crisis, when many banks with CRE concentrations failed, the number of community banks with CRE concentrations has steadily been increasing in 2022.

Even though problem loans are not yet an issue, “banks with high CRE concentrations can be exposed to higher risk of credit deterioration,” the Fed declared. It said it was particularly concerned with land development and construction loans, which “can pose a greater level of risk than owner-occupied CRE concentrations.”

The Fed noted that there were some troubling signs of loan deterioration with the level of 30-to-89-day past dues increasing for the second quarter in 2022. That, coupled with changing economic conditions and greater remote work that may make it difficult to lease office space, has examiners concerned that banks “could be adversely affected by stress in the CRE sector.”

Scrutiny of risk management processes

Examiners will consider the loan composition and risk diversification in the CRE portfolio. They will want to see that banks have a strong risk management process in place, as all the regulators laid out in the 2007 interagency guidance on CRE concentrations.

Supervisors will pay particular attention to banks with total reported loans for construction, land development and other land that is 100 percent or more of the bank’s total capital, or if their total CRE loans represent 300 percent of more of the total capital, and the outstanding balance of the CRE loan portfolio has increased by 50 percent or more during the prior three years.

Banks that meet those thresholds do not need to reduce their concentrations, however. As we have advised in the past, community banks can support a high level of concentrations if they can justify their capital “is commensurate with the risk profile of their CRE portfolios.” That necessitates a strong strategic stress test that is part of the bank’s capital planning.

Examiners will be looking at:

  • Board and management oversight, with policy guidelines, controls, and a clear CRE lending strategy. The board must review and approve CRE risk exposure limits and justify changes to them.
  • Portfolio management. Banks should be managing the overall portfolio risk, not the risk of individual loans. They should have contingency plans to mitigate high CRE levels in the face of changing market conditions.
  • Management information systems should have sufficient detail to allow the C-Suite and board to identify, measure, monitor and manage CRE concentration risk.
  • Market analysis. Banks must have adequate and current sources of data and information to understand the factors affecting their footprint.
  • Credit underwriting standards
  • Portfolio stress testing and sensitivity analysis. It is crucial to understand what impact changing economic conditions can have on asset quality, earnings and capital.
  • Credit risk review functions

Banks should be asking these 10 questions to get ready for their next exam. Banks that don’t have a proper CRE risk management framework in place will be subject to “supervisory feedback, or changes to a bank’s composite or component ratings,” the FDIC noted.

Invictus can help community banks beef up their CRE risk management processes, justify their concentration levels, and ensure their stress tests will pass examiner scrutiny. Please contact Patti Casaleggio at to schedule a free consultation today. 


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