As the House prepares to pass Senate Bill (S.2155) simplifying capital rules for community banks (JRN 35:13 & 18), federal bank regulators have issued their own rule that will ease some of the financial burden incurred through commercial real estate (CRE) lending. The rule, published in the Federal Register on April 9th, doubles the threshold for CRE appraisals.
That may seem like another swipe at Dodd-Frank, but it’s not. In 1994 (24 years ago), banks were required to get a licensed, independent real estate appraisal on CRE loans valued at $250,000 or higher. Anything less than that still required an evaluation of the property value, but the banks were allowed to use publicly available real estate data rather than incurring the cost of a certified property appraiser.
Since then, property values have more than doubled in most parts of the country. Raising this limit from $250,000 to $500,000 is simply taking that into account. In fact, some bankers wanted the threshold to be higher, but the $500,000 limit was based on the Federal Reserve’s CRE Price Index, which is nationwide.
We believe this change will benefit both community banks and small businesses. As the price of CRE has gone up, some community banks have shied away from the sector leaving local businesses fewer options for financing. With the increased threshold, there will be more competition for these loans which will keep them more affordable for the borrower as well as the lender.
The 50 banks listed on page 7 all have CRE loans that represent more than 10% of assets and all had huge increases in the CRE loans on their books during calendar 2017. Most of them are rated 3½-Stars or better but two of them jump out.
Zero-Star First Citizens Bank of Polson, MT and 2-Star Old Dominion NA in VA. Both have been operating under OCC (Office of the Comptroller of the Currency) enforcement actions for several years. We took a preliminary look at their March 31, 2018 financial data to evaluate the quality of their loan portfolios.
During the first quarter of 2018, First Citizens Bank of Polson charged off $3,000 of loans. They were all loans to individuals—not credit card or auto—but other consumer loans, with another $21,000 in arrears. It also has $342 thousand in past due single family home loans and $39,000 in other construction and land development loans in nonaccrual status. The amounts are small, but so is the bank, with only $19 million in assets at 3/31/18.
As part of its enforcement action, the OCC has a laundry list of requirements and details to “improve the Bank’s loan portfolio management”. So much, in fact, we are very surprised to see a 350% increase in CRE lending during 2017, particularly given its low capital levels. This one may not end well.
Old Dominion, on the other hand, has impressive capital levels. But, it charged of $184,000 in nonfarm nonresidential property in the first quarter 2018 and it is continually posting losses.
One of the things addressed in Old Dominion’s enforcement action is concentration of risk, yet over one-third of its loan portfolio is dedicated to CRE, less than a quarter is invested in single-family homes, which is generally a safer alternative.
The OCC should be monitoring both of these banks closely and we would not be surprised to see limits put on their CRE lending as a matter of course.
As for the majority of the banks listed on page 7, as long as they lend with prudence, they can help themselves and their communities by just continuing to do what they are already doing. Compared to fourth quarter, 2016, community banks loaned an additional $9.2 billion (3.2%) in small loans to businesses at year-end. That’s more than twice the annual rate of increase at noncommunity banks according to the FDIC’s Quarterly Banking Profile.
And with the new, higher threshold for mandatory appraisals, they can do even more for their local small businesses.
Community banks have always been an integral part of local CRE lending. As noted in the Federal Register, regulators agree that smaller institutions “are often better positioned than larger institutions to understand and quantify local real estate market values since they serve a smaller, more defined market area.” This new rule will allow them to continue to serve the people and businesses in their communities.
Of course, as with all loans, CRE loans must be underwritten prudently, with arms-length standards. If done properly, they should not pose any additional risk to the safety or soundness of the banks.