Quite possibly, all or most of the above will apply as we take a slightly tongue-in-cheek spin on one of the industry’s better-known acronyms, and the accompanying regulatory guidance that likely becomes elevated in future exams. In our February post, Do the CCAR Scenarios Signal Regulatory Focus? (February 16, 2017 – link below), we expressed the belief that the annual CCAR and DFAST process might foretell potential regulatory “hot buttons” and/or primary areas of focus for the banking sector. This past year’s hypothetical severely adverse scenario depicted, among other things, a swift and dramatic decline in commercial real estate (CRE) values:
“…most notably, the CRE Price Index shows a steeper and more pronounced drop in value when compared to past years. Reading the tea leaves, and noting the heightened regulatory awareness with regard to rising concentrations and pricing competition in banks’ CRE portfolios, I have to believe that this is a strong (and direct) signal to the industry that CRE will not only continue to be an area of focus for the regulators, but for those with growing or already tenuous concentration levels (i.e., approaching or beyond the stated 100%/300% guidance thresholds) it very likely will be the primary topic of discussion during regulatory exams…in light of preparing for the next economic downturn, banks with CRE concentrations that might otherwise cause some regulatory angst, should be able to demonstrate enhanced risk management practices and a deeper, more comprehensive understanding of their borrowers…”
With this tepid economic recovery coming out of the Financial Crisis, reflecting sub-optimal GDP growth and sluggish wage gains as unemployment levels dropped, the U.S. is tracking toward one of its longest (albeit modest) economic expansions in history following a downturn. This typically keeps most folks poised to address the implications and potential ramifications of the next recession looming on the horizon. Geopolitical uncertainty aside, if legislative gridlock in our nation’s capitol continues to stall and/or derail much-needed and highly-anticipated reform (tax, regulatory, healthcare, etc.) and hoped-for prospective economic stimulus programs, then recessionary fears probably become more prominent as we move forward.
The following graphs highlight relative “compliance” with the 300% CRE guidance promulgated by the regulators, first isolating Michigan and then comparing the state to both the Midwest and national figures:
Currently, only six of the roughly 90+ institutions in Michigan (or less than 7%) “breach” the 300% guidance threshold. This approximate 7% figure compares favorably to the national average (8%), while slightly more than the Midwest’s approximate 5% level. Looking a bit longer at the graph above on the left, we note that there are currently 19 Michigan-based banks that are north of 200% on this guidance measure. While the black-and-white stated ratio becomes an instant flash point with regard to “compliance”, the underlying dynamics of the institution, its history, and the expertise/experience of leadership will, in all probability, dictate any potential regulatory course of action.
As we have stated on this topic in the past, focus should center on the following:
–Ensure the existence of a strong balance sheet (both yours and your clients);
–Demonstrate sound portfolio management and enhanced underwriting standards (get out ahead of potential issues, both in the market and prospectively with the regulators);
–Routinely and systematically employ stress testing of your credits (which helps to underscore and reinforce your assessment of current and potential conditions/scenarios, the resilience of your operation, and ideally the depth and breadth of experience within your organization).
On the latter point, ProBank Austin has a long and extensive history of assisting banks with both broad and targeted stress testing exercises; please contact us if we can be of assistance in this regard.
In closing, attached please find our monthly summary of Michigan’s financial institutions. As you and your Board take your organizations forward, please do not hesitate to reach out to me and/or my colleagues at ProBank Austin if we can be of assistance in helping you assess the competitive landscape. Best wishes for continued success in 2017.