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NR 2010-32
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Comptroller Dugan Urges Action on Commercial Real Estate Concentrations

ORLANDO — Comptroller of the Currency John C. Dugan said today that the recent surge in community bank failures raises difficult questions for policymakers, and said that commercial real estate concentrations warrant special attention.

“Given what we know, I think we need to revisit the issue of the appropriate regulatory response to CRE lending concentrations, especially for construction and development lending, and especially for concentrations supported by non-core funding,” Mr. Dugan said in a speech before the annual convention of the Independent Community Bankers of America. “While the concentration guidance we issued in 2006 was necessary – even though it was opposed by many parts of the industry – in retrospect, it has obviously not worked as well as we would have liked.”

The Comptroller said that experience from the late 1980s and the early 1990s, and from the current period showed that significant concentrations in CRE lending leaves banks vulnerable to an economic downturn – “and the higher the concentration, the more vulnerable the bank.”

While a healthy economy will mask problems with poor underwriting for a while, Mr. Dugan said, a rapid buildup of commercial real estate loans is likely to overwhelm risk management controls, and some concentrations are so large that even the most sophisticated control systems cannot protect the bank from a serious economic downturn.

“We know that banks that build concentrations in CRE are more likely to rely on noncore and/or high interest funding,” he said. “And we know that significant CRE concentrations in economic downturns can lead to an increase in problem banks, an increase in bank failures, loss of jobs, loss of incomes, loss to communities, loss to the deposit insurance fund, and higher costs for all banks, even those that do not have CRE concentrations.”

Mr. Dugan said policymakers should consider a range of options such as harder limits, increased capital requirements, a more granular approach to defining concentrations (since not all CRE is the same), minimum underwriting standards, more stringent requirements for concentrations supported by substantial amounts of non-core funding, or some combination of the above.

Noting that newly-chartered institutions are overrepresented among bank failures, Mr. Dugan said consideration should be given to minimum federal standards for all newly chartered depository institutions, with a particular focus on business plans that call for significant CRE concentrations or reliance on non-core deposits for extended periods.

However, Mr. Dugan also warned that regulators should exercise care in moving ahead during the current economic environment. “We should not do any of this in haste, or in ways that would exacerbate the current problems of distressed banks,” he said. “Any course of action would have to be carefully phased in taking into account the current activities of all banks.”

The Comptroller said that while the vast majority of community banks are sound – nearly 80 percent of community national banks have CAMELS ratings of 1 or 2 – a growing minority have ratings that are lower, and problem banks represented almost nine percent of all insured depository institutions at the end of 2009. Since the start of the crisis, 195 banks, nearly all of them community banks, have failed, and projected failures this year are expected to exceed the 145 that were closed last year.

While regulators have been criticized both for being too tough and too lenient, Mr. Dugan said balance is critical. “We have to be forthright in addressing problems as we see them, and ensuring that bank management does exactly the same,” he said. “But we have to be equally careful not to overreact and make problems worse by acting too precipitously or being more stringent than we need to be. Striking that professional balance will not always be an easy task, but that comes with the job of being a good regulator.”

The Comptroller said that as issues arise over time, the OCC needs to do more to provide appropriate guidance, and needs to be sure that expectations are communicated to banks in a consistent way. One of the OCC’s strengths as an organization is its ability to ensure the consistency of messages to examiners around the country, he added.

In fact, we have tried very hard to get ahead of the commercial real estate aspect of this crisis through a series of communications to examiners and bankers beginning in 2005 and extending into this year,” he said. “While we were criticized early on as being unduly stringent relative to other regulators, we frankly have heard far less of that type of complaint recently – which we see as evidence of the consistency of our expectations.”

“Given the surge in losses, problem banks, failures, and costs to the deposit insurance fund – costs that will have to be borne by healthy banks for a very long time – I don’t think the status quo is acceptable,” Mr. Dugan said. “We need to take action, after thoughtful and careful study, to reduce the exposure of the industry and the insurance fund, to such large losses – before the next downturn comes, as it surely will.”

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