An Analysis of the Impact of the Commercial Real Estate Concentration Guidance
Print- Part 1: Executive Summary
- Part 2: Changes in CRE Concentrations over Time
- Part 3: The Impact of CRE Concentrations on Bank Failures
- Part 4: Impact of the Guidance and Market Conditions on CRE Loan Growth
- Part 5: Impact of CRE Concentrations on Banks’Market Capital Ratio
- Part 6: Conclusion
Part 5: Impact of CRE Concentrations on Banks' Market Capital Ratio
In this chapter, our analysis looks at the effect of CRE concentrations on banks' capital strength as revealed by equity market data. Option pricing theory provides a method for computing a market-based measure of a bank holding company's (BHC) capital position.12 This measure, referred to here as the market capital ratio (MCR), incorporates market knowledge of both the individual bank and of macroeconomic conditions to adjust the book value of assets. (Often, the book value includes components that are carried at cost and do not reflect economic reality.) Because it is based on market information, the MCR may be more forward-looking than more traditional capital measures that are based on reported financial data.
Our analysis looks at data for 325 publicly traded BHCs from the fourth quarter of 2006 through the first quarter of 2009. Reported book values come from the BHC's FR Y-9C call reporting forms, while the stock market data are sourced from the Center for Research in Security Prices (CRSP).13 Only BHCs that were both publicly traded and whose stock data could be identified in CRSP are included in the sample.
Reported loan amounts for CLD as well as total CRE are used in combination with the amount of total risk-based capital to classify each BHC as either over or under one of the concentration levels specified in the supervisory criteria. This initial classification is based on each BHC's status as of the fourth quarter of 2006. Then, each BHC is assigned to a particular cohort whose performance is tracked over time. The cohorts are defined based on various combinations of the supervisory criteria.Figure 6 reports some of the summary results of this analysis.
Note: Bank holding companies are assigned to both a CLD and total CRE cohort based on their loan concentrations as of 2006:Q4. Subsequent measurements of the cohort's average MCR are based on all the BHCs that have survived to date. Total CRE includes secured by non-farm, non-residential properties (owner-occupied loans were not separately distinguished within these loans until 2008:Q1).
Source: Y-9C call reports and CRSP.
The top panel in figure 6 reports the average MCR for BHCs that did not exceed either of the supervisory criteria concentration levels and for BHCs that did exceed at least one of the levels. Clearly, BHCs that exceeded both concentration levels began with lower MCRs at the time the guidance was issued and saw greater declines in their MCRs over time.
The middle and bottom panels in figure 6 repeat the analysis separately for each component and show consistent results.
Figures 7 through 12 illustrate changes over time in each cohort's MCR. The change in MCR is measured as the BHC's raw percentage decline between the fourth quarter of 2006 and the first quarter of 2009. The average decline is then calculated for each cohort, and confidence bounds are constructed using t statistics. The final row in each table uses a t-test to compare the difference in the declines of the two cohorts.
The group of BHCs whose CLD concentration was below 100 percent of total risk-based capital experienced a capital decline that was 3.6 percentage points less than those whose concentration exceeded 100 percent, as shown in figure 7. The BHCs below the total CRE concentration level of the supervisory criteria also saw a statistically smaller average decline in MCR than the average of those above the level, as shown in figure 8.
We next look at the effect of the total CRE supervisory criterion, which includes the growth component. When the growth component is used in conjunction with the total CRE concentration levels specified in the supervisory criteria, fewer banks are classified as exceeding the concentration level. Of the 325 BHCs, the data necessary to calculate the three-year growth rate were available for only 275, and only 36 of those BHCs had CRE representing more than 300 percent of total risk-based capital and more than 50 percent growth in their CRE concentration levels over the previous 36 months. The average decline in the MCR for these 36 BHCs was not significantly different from the average decline of the other 239 BHCs, as shown in figure 9.
Combining the classifications from figures 7 and 9 to create an overall guidance grouping shows that the BHCs that did not meet or exceed either of the supervisory criteria had a significantly smaller decline in capital than those that met or exceeded at least one. This grouping follows the same logic as the guidance itself. The estimated additional decline in the MCR for the group of banks that met or exceeded at least one of the supervisory criteria was 4.0 percentage points greater than the MCR decline for those that did not, as shown in figure 10.
Figure 7. Construction
| C&D cohort | Number of BHCs | Average change in MCR (percent) | 95 percent confidence bounds (percent) | |
|---|---|---|---|---|
| Lower | Upper | |||
| Over 100 percent | 160 | -12.5 | -13.3 | -11.8 |
| Under 100 percent | 165 | -8.9 | -9.7 | -8.2 |
| Difference | -3.6 | -4.7 | -2.6 | |
Source: Y-9C call reports and CRSP.
Figure 8. Total CRE only
| Total CRE cohort | Number of BHCs | Average change in MCR (percent) | 95 percent confidence bounds (percent) | |
|---|---|---|---|---|
| Lower | Upper | |||
| Over 300 percent | 188 | -12.3 | -13.0 | -11.5 |
| Under 300 percent | 137 | -8.6 | -9.3 | -7.8 |
| Difference | -3.7 | -4.8 | -2.7 | |
Source: Y-9C call reports and CRSP.
Figure 9. Total CRE with growth component
| Total CRE cohort | Number of BHCs | Average change in MCR (percent) | 95 percent confidence bounds (percent) | |
|---|---|---|---|---|
| Lower | Upper | |||
| Over 300 percent and > 50 percent growth | 36 | -11.5 | -12.7 | -10.4 |
| Under 300 percent or < 50 percent growth | 239 | -10.3 | -11.0 | -9.7 |
| Difference | -1.2 | -3.0 | 0.6 | |
Source: Y-9C call reports and CRSP.
Figure 10. Dual guidance category
| Guidance group | Number of BHCs | Average change in MCR (percent) | 95 percent confidence bounds (percent) | |
|---|---|---|---|---|
| Lower | Upper | |||
| Above at least one threshold | 166 | -12.5 | -13.2 | -11.8 |
| Below both thresholds | 140 | -8.6 | -9.3 | -7.8 |
| Difference | -4.0 | -5.0 | -2.9 | |
Note: Based on total CRE growth provision.
Source: Y-9C call reports and CRSP.
Finally, figures 11 and 12 illustrate the marginal effect of the total CRE component of the supervisory criteria with and without the growth component. When the growth component is ignored, BHCs with CLD concentration levels below 100 percent, but total CRE concentration levels above 300 percent, show a significantly larger decline in MCR than BHCs that are under both concentration levels. When the growth component is incorporated, however, that added decline in MCR is no longer statistically significant. This lack of significance may be due at least in part to small sample size, because only six BHCs had a CLD ratio lower than 100 percent while simultaneously exceeding the total CRE 300 percent concentration level and meeting the 36-month CRE growth component.
Figure 11. Total CRE conditioned on construction
| C&D cohort | CRE cohort | Number of BHCs | Average change in MCR (percent) | 95 percent confidence bounds (percent) | |
|---|---|---|---|---|---|
| Lower | Upper | ||||
| Under 100 percent | Over 300 percent | 49 | -10.4 | -12.0 | -8.8 |
| Under 100 percent | Under 300 percent | 116 | -8.3 | -9.1 | -7.5 |
| Difference | -2.1 | -3.7 | -0.3 | ||
Source: Y-9C call reports and CRSP.
Figure 12. Total CRE with growth conditioned on construction
| C&D cohort | CRE cohort | Number of BHCs | Average change in MCR (percent) | 95 percent confidence bounds (percent) | |
|---|---|---|---|---|---|
| Lower | Upper | ||||
| Under 100 percent | Over 300 percent and > 50 percent growth | 6 | -11.9 | -15.8 | -8.0 |
| Under 100 percent | Under 300 percent or < 50 percent growth | 140 | -8.6 | -9.3 | -7.8 |
| Difference | -3.3 | -7.2 | -0.6 | ||
Source: Y-9C call reports and CRSP.
References
12. The MCR is equal to one minus the ratio of book debt to market implied value of assets. The market implied asset value is determined by assuming the bank's equity is a call option on assets (the Merton model). Stock market data provide measures of the value of equity and equity volatility. For a discussion of methods and the underlying theory, see Gizycki, M. and M. Levonian. "A Decade of Australian Banking Risk: Evidence from Share Prices." RBA Research Discussion Papers. Reserve Bank of Australia, 1993 (http://econpapers.repec.org/RePEc:rba:rbardp:rdp9302 
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13. The FR Y-9C reporting form collects basic financial data from a domestic BHC on a consolidated basis in the form of a balance sheet, an income statement, and detailed supporting schedules, including a schedule of off-balance-sheet items. CRSP is a non-profit research center at the Booth School of Business of the University of Chicago that provides historical stock market data. Return to text