Keynote at S&P Global Conference on CRE Risk Management

I’m honored to speak alongside President Rosengren. We appreciate all his work at the Boston Fed and with our member banks in that region.

I’m also pleased to be able to represent America’s banks in this important and timely conversation about commercial real estate risk management.

CRE lending is a crucial line of business for many ABA members. Today, banks have $1.75 trillion in CRE loans on their books. For larger banks – those with more than $10 billion in assets – these loans comprise about 17 percent of the bank’s portfolio. But they comprise 24 percent of the portfolio of a typical community bank, for whom CRE is bread-and-butter lending.

This reflects not only strong demand. It also reveals how well suited community banks are to CRE lending, given their detailed knowledge of local markets, the close connection with their customers, and their ability to tailor loans to meet their customers’ specific needs.

The success of any commercial enterprise depends on having a strong and realistic business plan. Banks take great pride in advising their business customers about such plans, providing the kind of personalized service that is so important in business lending.

Funding commercial real estate projects is among the many ways that banks help their customers and communities grow and thrive – provided, of course, that the loans are well underwritten and the portfolios prudently managed.

ABA’s member institutions are sensitive to the need for such diligence. Today’s bankers survived the Great Recession so are keenly aware of the risks in commercial real estate lending and the importance of managing them well. Quite frankly, no one has more interest in making sure these loans are solid than the banker on the other end of the deal.

That being said, CRE lending is no easy exercise. Real estate markets shift quickly, and lags in development and oversupply can have a big impact on the success of any project.

So how do the risks today compare with those nearly a decade ago?

To answer that let’s review some of the critical achievements banks and regulators together have made since the crisis of 2008. I will also highlight some regulatory changes that ABA thinks can ensure the CRE market functions in a way that maximizes potential while maintaining soundness.

Big Picture

Since the 2008 crisis, banks have increased capital 44 percent. At the end of 2016, 99.2 percent of all banks were well-capitalized, which is the highest regulatory capital standard. Total industry capital and reserves are nearly $2 trillion.

That capital, along with continued deposit growth, has been used to support robust growth in business lending as well as commercial real estate and construction lending. Since the end of 2008:

• Loans to businesses are up 30 percent
• CRE lending is up 25 percent

Asset quality has also remained healthy. Even though net charge-offs in the last quarter of 2016 rose, charge-off rates were near historic lows at 0.47 percent – well below rates observed during the recession.

Another measurement of the industry’s ability to absorb credit losses – banks’ A-tripleelle [ALLL stands for Allowance for Loan and Lease Losses] reserve coverage ratio – was 92 percent, the highest level since before the crisis.

So the current snapshot of banking indicates overall health. The only real asterisk that FDIC Chairman Marty Gruenberg offered to this good report card in February was concern that some banks were exposed to interest rate risk, liquidity risk and credit risk because they had “reached for yield” during our prolonged period of historically low interest rates.

That period is coming to a close. The Federal Reserve, as we know, is considering additional rate increases this year to prevent the economy from overheating.

And while rate increases can present some risk, we believe regulators’ warnings and banks’ own risk management practices have helped banks prepare well for this inevitability. In fact, these increases have been anticipated for so long that banks have had ample time to factor potential risks associated with them into their asset and liability management plans.

CRE Trends/Risk Management

Likewise, banks are attuned to the risks at play in their local commercial real estate market.

In fact, the Federal Reserve’s Community Depository Institution Advisory Council, which met last month and includes several ABA member bankers, reported seeing some pullback from CRE and construction lending due to concentrations, overbuilding and growing concerns from bank management and regulators alike. The Council members said that community institutions generally are maintaining good structures for CRE deals, though they noted significant competition in certain markets has driven loans to longer tenure at lower rates.

A bank’s job, as a lender, is to manage risk, not avoid it entirely. As engines of economic growth in towns and cities across America, banks seek to identify and support opportunities to help businesses expand and create jobs. Done right, commercial real estate finance presents such opportunity. And managed right, portfolios with CRE concentrations are similar to other risk-management tasks that bankers face every day.

The key lies in a bank’s risk management – a critical process that is at the very core of banking. ABA seeks to supplement the daily risk management at our member banks with information and resources that can further help them manage their risks more effectively. We do this with the help of a committee of bankers we established after the financial crisis. Our Commercial Real Estate Lending Committee, which now has about 150 members, meets monthly via conference call and twice a year in person to discuss CRE lending trends, policy issues and risk management best practices. Every in-person meeting also includes a dialogue with senior regulatory officials.

We staff those meetings with subject matter experts at ABA, who also prepare a monthly newsletter to keep bankers informed on key CRE issues. Our newsletter last month, for example, examined recent regulatory perspectives on CRE, including findings of the Fed’s senior loan officer survey, which showed banks on net are tightening underwriting standards for CRE loans.

It also spotlighted FDIC’s heightened focus on these loans, and it detailed weaknesses that some of the agency’s examiners have spotted that banks should seek to avoid. It also spotlighted FDIC’s heightened focus on CRE loans, and it detailed weaknesses that some of the agency’s examiners have spotted that banks should seek to avoid.

And, importantly, the newsletter discussed the OCC’s continued focus on sound CRE concentration risk management in the course of its examinations – a hopeful sign of the supervisory interaction with the banker that is a mark of a good bank examination. Other resources we offer our members include expert training for employees and due diligence on products that can help banks better manage their risk. We have, for example, pointed our community and regional bank members to a powerful and easy-to use tool to stress test their CRE portfolios.

Regulatory Improvements Needed

Of course, strong risk management is essential for banks to deliver sustainable growth – a goal that both banks and regulators share. Given this shared goal, ABA and our members seek to maintain an open and candid dialogue with the banking agencies.

It’s tempting for some to characterize the bank-regulator or bank-examiner relationship as fraught with friction, with the two sides engaged in a perpetual tug-of-war over the interpretation and application of rules. While I think a certain amount of tension is healthy, an “us-versus-them” frame is not quite right. Nor does it point to the ultimate goal of bank supervision, which is to help banks succeed.

In that sense, banks and their supervisors are both on the same team, albeit with occasionally different opinions about the best way to win the game.

And with that in mind, I would like to touch briefly on some regulatory changes we believe – and in some cases regulators agree! – will better help banks do their job.

Clearer Guidance

The first is clearer guidance. In April, Treasury Secretary Steven Mnuchin held a roundtable discussion with several community bankers to gather information about regulations that are impeding economic growth. The meeting was part of Treasury’s implementation of President Trump’s executive order on financial regulation. The secretary has until June 3 to report back to the president on rules or laws that should be repealed, revised or at least revisited.

Among the issues our community bankers raised at that meeting is the disparity in how supervisors interpret the regulators’ 2006 guidance on CRE concentrations. That document included guidelines – and I emphasize the word guidelines – on CRE concentration limits that some examiners have treated as firm limits, regardless of a lender’s strong underwriting standards, strong levels of oversight and strong loan performance over time.

This can stand in the way of banks meeting local credit needs and limits business activity and job creation. Guidelines should lead to a banker-supervisor conversation that leads, in turn, to a mutual understanding of how to meet local needs in a safe and sound manner. This is how bank supervision is supposed to work.

When guidelines become unquestioned barriers, they limit a local bank’s ability to serve local credit needs in an effective, tailored way. This is the community bank’s competitive advantage. Limiting it has a high potential for driving increased consolidation by taking away what the community bank does best.

Appraisal Relief

Another area where banks and regulators alike see the need for relief is appraisals. Since 2007, the appraiser workforce has shrunk by more than 20 percent, and the Appraisal Institute estimates an additional 25 to 30 percent drop over the next decade.

This, combined with the fact that the thresholds governing when CRE loans require an appraisal have not been updated since 1994, has increased costs and delays associated with real estate transactions.

Thanks to the agencies’ Economic Growth and Regulatory Paperwork Reduction Act process that concluded this year – a once-a-decade review that in the past did not yield significant changes – some relief may be on the way. In their report to Congress in March, the federal financial regulators indicated they are developing a proposal to increase the threshold for CRE loans from $250,000 to $400,000. They also are looking into the possibility of increasing the $1 million threshold related to real-estate-secured business loans.

This is welcome relief, as are efforts to address the shortage of appraisers, particularly in rural areas. ABA is urging the Appraiser Qualifications Board to decrease the number of experience hours required to obtain an appraiser certification, and we have supported a proposal to remove the bachelor’s degree requirement.

HVCRE

A third area requiring attention relates to capital requirements.

There is now widespread agreement that the definition of what constitutes high-volatility CRE under the regulators’ Basel III capital rules is overly complex. These are the rules that assign a static, generalized 150 percent risk weighting to acquisition, development and construction loans, subject to certain criteria.

Regulators speaking at ABA’s recent real estate lending conference indicated that revisions to these rules may be proposed this summer. The potential changes could include a simpler definition of HVCRE, which bankers and even lawmakers have been requesting.

Exemptions and other modifications may also be needed, especially to recognize the value of long-held land that has appreciated in value.

Stress Tests

The last issue I want to briefly mention is the one that your next panel will probe in much greater depth.

I think we can all agree that surprise is unwelcome to both bank supervision and bank management. For that reason, ABA believes strongly that changes are needed to the stress testing regime governing banks of various sizes.

For CCAR banks, the design and assumptions of the supervisory model and the supervisory scenarios are sorely lacking in transparency. Though the stakes associated with the stress tests are high, the details of the program have not been properly exposed for public comment. As ABA noted in a recent white paper to Secretary Mnuchin – which is posted on our website, aba.com – principles of safety and soundness should not be a mystery. Rules should be sufficiently consistent and transparent so as to encourage appropriate risk management practices – not surprise banks and the customers who rely on them and the investors who support them.

The supervisory models and scenarios of the stress tests directly affect how much capital a bank needs to hold for particular assets. This can force banks to shift lending away from sectors that are disfavored by the regulator’s supervisory model and scenario assumptions, potentially affecting credit availability in certain sectors. For these reasons, we think the opportunity for public review and comment is essential.

ABA also is advocating elimination of the opaque qualitative assessment for CCAR banks – something regulators saw fit to do for banks in the $50-$250 billion range.

Furthermore, we think the Dodd-Frank-mandated company-run stress tests do not make sense for midsize banks. Regulators seem to agree, though formally exempting such banks would require legislation.

Conclusion

While we have suggestions for regulatory improvements, let me be clear that banks value strong regulation. Rules that reinforce prudent risk management and protect borrowers are critically important. So are rules that are tailored to a bank’s risk profile and business model – not simply its size.

Over the past 200 years, the country has built up a banking industry that is as varied and diverse as the customers we serve. Regulation should encourage that diversity, not undermine it with ill-fitting rules that make it harder to serve the different needs of borrowers.

Tailored regulation can also help ensure a regulation’s costs do not well exceed its benefits. Those costs might come in the form of delayed or more expensive transactions. They also could come in the form of a loan to a creditworthy borrower that was lost.

The commercial and multi-family real estate industry plays a critical role in our nation’s economy, generating more than 20 percent of America’s GDP.

ABA’s goal is to help our members safely navigate this important market, pursuing regulatory improvements as appropriate so that banks can continue to help people and places across America grow.

Thank you.