FDIC Raises Concerns about Construction and Real Estate Lending
The rapidly escalating construction and real estate lending volume by commercial banks has not gone unnoticed by the Federal Deposit Insurance Corp. (FDIC). The FDIC, which is responsible for insuring deposits at the nation’s 11,191 banks and savings associations in addition to auditing the institutions for safety and soundness, recently voiced its concerns after reviewing a report that examined 1,233 FDIC-supervised institutions.
"Loan growth and increased competition are the typical reasons that banks reduce their underwriting standards," said FDIC Chairman Andrew C. Hove, Jr. "Currently, there’s no cause for alarm, but our results show that certain underwriting practices, especially involving construction and commercial real estate loans, should continue to be monitored carefully."
About 32 percent of banks in the survey (398 institutions) wrote construction loans. The FDIC was particularly concerned that nearly a quarter of those banks frequently wrote loans on properties without commitments for a sale or lease. Funding such speculative projects brings back memories of the late 1980s, when speculative overbuilding led to crisis conditions in the office market during the early 1990s. This cycle of overbuilding is considered a significant factor in the savings and loan debacle.
Fortunately, recent development has been in response to demonstrated demand, and newly constructed speculative office buildings are being absorbed rapidly. In fact, absorption outpaced construction dramatically during the 1990s.
The survey also indicated that about 53 percent of the participants (659 banks) wrote real estate loans. The FDIC also is concerned over the significant number of banks making nonrecourse loans. About 11 percent of the banks failed to consider alternative repayment sources, other than the project funded, on a basis frequent enough to warrant notice. In the late 1980s and early 1990s, nonrecourse loans swelled banks’ real-estate-owned (REO) portfolios, asset values plummeted, and bullet loan holders could not obtain refinancing.
The FDIC also raised concerns about concentration risk. About 13 percent of the respondents (160 banks) had a high concentration of loans to one borrower or industry for new loans. Seven percent (86 banks) commonly had high concentrations of existing loans to one borrower or industry.
Areas of Improvement
In addition to its concerns, the FDIC also reported areas showing improvement. For instance, the number of banks increasing their underwriting standards surpassed the percent of banks decreasing their underwriting standards, 6 percent versus 4 percent, respectively. In addition, the percentage of banks that had above-average risk in underwriting practices or above-average risk in loan administration has decreased.
The good news about the bad news in the FDIC report is the rapid discovery of issues that warrant close monitoring. In 1995, the FDIC implemented an examiner-reporting system that allowed bank underwriting and lending practices to be identified immediately. Maintaining a constant vigil over bank lending and underwriting practices will prevent imprudent bank lending policies from swelling into a national trend.