Comptroller Dugan Urges Stronger Risk Management For Commercial Real Estate Loans, And Discusses Money Laundering Supervision

WASHINGTON—Pointing to potential stresses ahead in commercial real estate lending, Comptroller of the Currency John C. Dugan said community banks engaged in this business need to assess the strength of borrowers and identify problem credits at an early stage.

In a speech to the Independent Bankers Association of Texas, Mr. Dugan said community banks with significant concentrations of commercial real estate need to be especially prepared.

"You need to make sure your officers and loan review staff realistically assess the strength of your borrowers, and identify problem credits early," Comptroller Dugan said. "You should also ensure that you have adequate loan loss reserves to cover the increase in losses that may occur."

Mr. Dugan also cited the effect of the decline in residential home sales, which constituted a significant portion of construction and development loans. "During the last year national community banks outside of Texas have experienced a significant increase in construction and development loans that are 30 days or more past due – more than doubling from 1.2 percent at June 2006 to 2.6 percent at June 2007," Mr. Dugan said. He said this trend clearly bears watching.

Community banks have begun using stress testing, at least to analyze different interest rate scenarios, the Comptroller said.

"But given the high level of concentrations, banks should also be stress testing other business variables that affect risk, such as vacancy rates, lease rates, and expense scenarios – not only at the time the loan is made, but also periodically throughout the life of the credit relationship," he added.

The result of enhanced risk management will also affect loan loss reserves. "I firmly believe that in this environment, increases in loan loss reserves for many banks are both warranted and prudent," Mr. Dugan said.

The Comptroller also addressed issues stemming from management of money laundering risk in community banks, and discussed the OCC's efforts, through the agency's Money Laundering Risk (MLR) system, to segment banks according to risk, so that more supervisory efforts are devoted to riskier banks and fewer to banks that need it least.

"According to MLR metrics, the vast majority of OCC's community national banks are considered low risk; specifically, 89 percent are low risk; seven percent are moderate risk; and only four percent are high risk," Mr. Dugan said.

Translated into exam workdays, the average BSA exam workdays for lower risk banks is about four days; for moderate risk banks, 10 days; and for higher risk banks, 22 days.

The OCC's system also provides benefits for peer analysis. "In fact, this is the first time that peer information for BSA risk has been available and provided to the banking industry, which we think really does help let you know where you stand," the Comptroller said.

"This is a tool that really helps measure BSA risk in community banks, which over time we believe will help lead to fewer supervisory resources and less regulatory burden directed towards the vast majority of community banks, which are lower risk, with more resources focused on those higher risk banks that really need it," Mr. Dugan said.

Related Links

• Remarks Before the Independent Bankers Association of Texas (PDF)
• Comptroller of the Currency John C. Dugan