Recently two snippets from a well-known banking industry daily publication caught my eye. One simply focused on the number of banks in the United States concentrated in Commercial Real Estate (CRE) loans, while the other was titled “Financial Regulators Clarify Guidance Is Not Regulation.” Both, for me, served to coalesce around a prudent, best-practices approach to managing one’s loan portfolio and monitoring various concentrations, while the other, subtly, seemed to reinforce the shifting regulatory “tone from the top” to pursue more constructive paths to oversight versus potential after-the-fact punitive courses of action when challenges arise. The latter was succinctly summarized during a congressional hearing this past June, when Comptroller of the Currency, Joseph Otting, stated to Congress:
“Guidance is guidance, and rules are rules. We’ve taken an aggressive posture to make sure that is known within the agency.”
Much consternation has arisen as institutions gauge their real estate concentrations, and prospectively what the regulatory response might be based upon those levels. As the graphs below summarize, when looking at both national averages and Michigan’s profile, concentration levels across the industry have been moderating as the economic expansion begins to get a bit long in the tooth. Even in Michigan, after a bit of a spike in CRE concentrations earlier in the year, overall levels too appear to be declining in the aggregate. Specifically, putting context to the below graphs, approximately 8% of banks across the country exceed either or both of the CRE “guidance” measures framed by the regulators, while those same metrics equate to roughly 6% of Michigan’s financial institutions. While the black-and-white stated ratio becomes an instant flashpoint 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:
We are in an environment that continues to reflect solid economic growth, continued low unemployment, and inflationary pressures seemingly well under control. Add to this the sense that investor confidence remains strong while market volatility has been manageable, and the looming concerns about a potential inversion of the yield curve (and the recessionary fears such an occurrence often portends) and the possible unintended (negative) consequences of tariffs and forecasted trade wars clearly seem to frame an economic conundrum.
In an industry prone to lean on sports analogies to conveniently highlight trends and developments, we often hear, as it relates to the economy, that we are in the ___ inning of a nine-inning game. Recently, I heard the following, paraphrased, from a seasoned investor and market prognosticator, and it hit a responsive and insightful chord for me: we are probably in the 8th inning of an 11-inning game. Since baseball games are by design expected to conclude after 9 innings, I thought the statement was a clever way of somewhat capturing consensus opinion that we are probably late into this economic expansion, but at the same time existing underlying economic trends and market indicators seem to be signaling that we are also “going extra innings” in the current cycle.
This typically keeps most folks poised to address the implications and potential ramifications of the next recession looming on the horizon. Geopolitical uncertainty aside, this economic expansion will at some point come to an end. Best positioning your bank in terms of underlying strength and resiliency related to capital, the loan portfolio and funding considerations while the sun is still shining, ideally better aligns the organization when the inevitable rains come.
Pro-actively stress your loan portfolios, particularly your CRE-related credits. Assess potential liquidity threats (especially against the expectation of deposit betas possibly/probably accelerating), and consequently possible alternative funding sources. Look back at your costs and resource-allocation challenges experienced during the Financial Crisis to help gauge the resiliency of your staff and your organization for the next downturn. Ideally, the end of this cycle will not be nearly as severe as the debilitation experienced during the recent Great Recession, but prepping for it should provide some sense of comfort as the next slowdown approaches.
And as it relates specifically to CRE concentrations, as we’ve 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, by the way, ProBank Austin has a long and extensive history of assisting banks with both broad and targeted stress testing exercises, so please do not hesitate to contact us if you believe 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 any assistance in helping you assess the competitive landscape. Best wishes for continued success in 2018!September 2018 Michigan Bank Summary