Part 6: Conclusion

This paper reviews bank failures during the recent economic downturn in the context of the 2006 interagency guidance. Three findings emerge from our analysis that provide a valuable perspective on the guidance. First, many banks identified as having high levels of CRE concentration levels either failed or saw their market valuations decline. Second, banks that lowered their CRE concentration levels did so primarily by reducing their exposures to CLD loans. Finally, we observed banks that were identified as having high CRE concentration levels actually expanding their CRE portfolios, primarily by increasing their holdings of non-CLD CRE loans.

We have discussed how the language of the guidance clearly states that the supervisory criteria were not intended to set hard caps on banking institutions' CRE concentration levels, but rather to define a level above which banks should be able to demonstrate enhanced credit risk management, which may include stress tests of the appropriate level of sophistication. We have found that, while the number of banks for which the supervisory criteria are applicable has declined dramatically since 2007, the criteria are still applicable for a non-trivial share of banks that holds a disproportionate amount of CRE loans. Further, we have found that the growth component, an oft-overlooked component of the total ratio criteria, significantly limits the number of institutions for which the criteria applies.

We have also validated the concerns that motivated the issuance of the guidance: CRE concentrations indeed have been a significant factor in post-2006 bank failures. Concentrated exposure to CLD loans, in particular, appears to have been the dominant risk driver. Further, we have found that banks have responded to market conditions and the supervisory criteria by shrinking their holdings of CRE portfolios, particularly with respect to their CLD loan portfolios. Finally, we have demonstrated that regulators' concerns regarding CRE concentrations are also evident in market-based measures of bank condition: Banks with excessive CRE concentrations saw greater declines in market capital ratios during the recent economic downturn.