Loan Growth Brings Continued Focus on Concentrations
As U.S. banks continue to see strong loan growth, bank regulators are watching closely to ensure banks adequately identify and manage concentration risk. In March, the FDIC devoted its Winter 2016 edition of its Supervisory Insights newsletter (Newsletter) to this topic, and while the FDIC examines only a subset of U.S. banks, its comments on this subject are generally applicable to all insured financial institutions. In case you missed it, here is a recap of some of the Newsletter’s main themes.
1. Commercial real estate, agricultural, and oil and gas lending concentrations are in the spotlight. The FDIC provides statistics regarding how these industries are faring and how banks with concentrations in these areas compare with other banks with respect to capital, funding, return on assets and other performance indicators. In light of the trends and volatility in these areas, banks with these concentrations are likely to receive heightened scrutiny.
2. Concentrations should be identified early and managed aggressively, especially during times of growth.Regulators pay special attention to banks with rapid growth in commercial real estate (CRE) lending or notable exposure to a specific type of CRE, or that are approaching (a) total reported loans for construction, land development and other land equal to 100 percent of total capital; or (b) total CRE of 300 percent of total capital where the outstanding balance of CRE has increased 50 percent or more in the past 36 months. Agricultural lending concentrations may also be identified using the 300 percent of capital benchmark. The Call Report does not capture oil and gas lending, but banks operating in areas that are heavily dependent on energy-related industries are directed to consider their direct or indirect exposure to these industries. Upon hitting or approaching a concentration threshold, examiners will likely apply increased scrutiny to the bank’s risk mitigation efforts, which may include stronger credit and liquidity oversight, enhanced management information systems and reporting, more robust loan review and ALLL policies and practices, and potentially, higher capital levels.
3. Board oversight of concentrations is considered a critical responsibility. Management is expected to update the board regularly regarding the status of bank concentrations and trends toward concentrations. Board-imposed policies and limits on concentrations should be updated when appropriate, which may be more often than annually during times of rapid growth. To show examiners the board is actively involved in this area, board actions and discussions should be documented in minutes.
4. Concentrations may arise with particular industries, geographies or borrowers. Some concentrations are easier to spot than others. Traditionally, banks monitor concentrations in certain loan types or industries, but concentrations can be tied to other factors. For example, while oil and gas lenders tend to be larger banks, often community banks lend to companies that indirectly support the oil and gas industry, such as motels and restaurants. Regulators increasingly consider whether a bank’s exposure to a particular borrower or group of related borrowers may raise concentration risk, even in cases where the relationships are not in danger of hitting legal lending limits.
5. Supporting growth with wholesale funding will draw scrutiny. For purposes of the Newsletter, “wholesale funding” includes federal funds purchased and securities sold under agreements to repurchase, other borrowed money, brokered deposits, deposits gathered through listing services and uninsured deposits of state and political subdivisions. The FDIC considers reliance on wholesale funding to be one of the contributing factors to failures during the recent financial crisis, so banks are expected to ensure that loans funded through these sources are prudently underwritten and appropriate for the bank’s risk appetite and strategic plan.
Concentrations are often inevitable for community banks in order to meet the credit needs of the areas they serve. Regulators expect banks to identify these risks within their loan portfolios and take proactive, documented steps to mitigate them.