What Every Community Bank with a CRE Concentration Needs to Do Before March

community banks with high cre concentrations need to act now

If you work for a bank that has a CRE or construction concentration, you most likely know that regulators have you in their cross hairs. I’ve seen several instances over the last few weeks in which examiners have notified banks they will be conducting off-cycle examinations. The reason: the bank showed up on a canary report due to its CRE concentration levels.

Whether your next exam is in December of 2022, December of 2023, or somewhere in between, I am proposing that every bank with a CRE concentration stop now and begin working on a 90-day plan. It’s critical.

Why the next 90 days in particular? Because we are currently in strategic planning and budgeting season. For most banks with fiscal calendar years, the plans for next year and beyond are in the works right now. And examiners will be focusing on what you include (or don’t include). It’s make-or-break time.  

Frankly, this playbook is not just to prepare for regulatory exams, it’s also good, simple, sound enterprise risk management. OK, I’ll get off my high horse. If we get to the right answer for the wrong reasons, I’ll call that a victory for everyone involved, including banks and regulators.


The Objective: Get a Formalized Capital Plan in Place

Step 1. You need to have a capital plan completed and ratified by the Board of Directors by the end of February. However, this is important: Your capital plan cannot just be a cobbled together word document with no teeth. The capital plan must include limits and triggers for regulatory capital ratios and concentration levels at both the aggregate CRE and property type level. Other concentration segments within CRE may also be necessary -- such as by market or NAICS code, depending on your business model.

But these limits and triggers cannot be plucked out of thin air. You must be ready to support and defend them with data and analysis. And they should also be adjusted to reflect your existing balance sheet, earnings capabilities, strategic plan, and external conditions, such as the elevated threat of recession and tightening monetary policies.

You also need key risk indicators to serve as early warning triggers. One example is the Classified Assets-to-Capital Ratio. If your capital plan is missing this ratio, it’s worthless. There are other essential ratios, too.

Think of the limits and triggers within your capital plan as guardrails for your strategic plan. You don’t want those guardrails in too close, but you don’t want them too wide, either. If the guardrails are reasonable and supportable, then your regulators will be happy, your board will be happy, and management will be happy. It’s the ultimate compromise, if done properly.


Prepare for what can go wrong

The capital plan should also include policies and procedures that will be followed in the event of a breach. For instance, what happens if a trigger or two are tripped? On one hand, you don’t want a capital plan that forces you to over-react by having to take drastic measures such as shutting down loan growth or cutting dividends. On the other hand, it is also inexcusable to not react at all and pretend the breach didn’t happen. For example, it is perfectly acceptable for the policy to say that in the event of a trigger being breached, management will (a) alert the board and (b) report back to the board on whether the breach is just temporary or if actions are required. Limits are different though because they should represent thresholds that automatically drive actions to be taken without any discretion.


The Board Must Be Involved

Step 2. The board’s ratification can’t be a fleeting agenda item. Too many banks draft their capital plan for regulators. They’ve never presented it to the board, and it hasn’t been updated in years. To do this right, the capital plan should be presented to the board in tandem with the strategic plan. The capital plan should be ratified by the board as part of its fiduciary responsibilities and stewards of the bank’s capital. In other words, make sure your board has skin in the game.

The board’s fiduciary duty is obvious, but technical. Regulators want to see that the bank has the infrastructure in place to govern itself. That is the most important impression you want to make as a bank. And the best impression is always an authentic one. Regulators have finite resources. Force them to concentrate their resources on those banks with CRE concentrations, but are missing strong boards and well-designed capital plans. If you follow my advice, that won’t be your bank.

Get the capital plan in front of the board of directors no later than March so that your 2023 Budget has the appropriate guardrails in place. That gives you 90 days to start the analytical process, designing, and writing of the plan.


Don’t Make your Capital Plan a Bulky Document

When it comes to capital plans, less is more. Get rid of all the fluff, please. This doesn’t need to be a risk assessment textbook. Your capital plan should only be a handful of pages (page numbers should be in single digits!). All that matters in a capital plan are the triggers and limits, and what happens when they get breached. Focus your energy on that.

Also, capital plans need to be agile. They should be updated once per annum, at minimum. And they should be updated with the strategic plan or budget. As your bank evolves and external conditions change, the triggers and limits within your capital plan also need to change.

Your capital plan could be 300 pages (yikes if it is!), but if your triggers and limits are missing or meaningless, then the weight of the plan as measured in pages doesn’t matter.  

At the end of the day, capital planning should be a dynamic process, not a static one.


The End Results

If you have an exam starting before March, you can show the regulators that you are on the right path. If you have an exam starting after March, you will be fully prepared. And back on my high horse, you will authentically demonstrate best practices in capital planning and risk management.


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Invictus Can Help

Invictus specializes in assisting banks with CRE and construction concentrations. We help banks use data and analytics to quantify customized internal capital thresholds, concentration triggers and limits, and integrate stress testing into capital plans and CECL frameworks. If you have a CRE concentration and either have an upcoming exam or recently had an exam that included formal actions (such as MRAs or MRBAs) related to managing CRE concentrations, please reach out to Patti Casaleggio pcasaleggio@invictusgrp.com to schedule a consultative session to learn how Invictus can help.