FDIC Failed to Limit CRE Lending

From Bloomberg:

The Federal Deposit Insurance Corp. failed to enforce its own guidelines to rein in excessive commercial real estate lending by at least 20 banks that later collapsed, reports by the agency’s watchdog show.

The FDIC’s Office of Inspector General analyzed 23 lenders taken over by regulators from August 2008 to March and found that for 20, the agency’s examiners didn’t identify the issue early enough or should have taken stronger supervisory action after recognizing the banks had dangerously high levels of the loans before they failed.

The failure to follow up on the 2006 recommendation, that banks avoid letting commercial real-estate holdings exceed 300 percent of capital, has emerged as FDIC Chairman Sheila Bair steps up her effort to expand the agency’s role in regulating the financial-services industry.

“We should ask the prudential regulators why they did not do more to push banks to pay attention to their guidance,” Representative Brad Miller, a Democrat from North Carolina, said in an interview. “If they thought their conduct was unsafe, it’s unsound, they certainly should have stopped it.”

Miller sits on the House Financial Services Committee, which oversees the FDIC and the banking industry.

“We are in process of addressing any existing gaps in supervisory policy with respect to commercial real estate lending,” FDIC spokesman Andrew Gray said in a prepared statement. “The FDIC has also stepped up our off-site surveillance program to assist our examiners in targeting those institutions with elevated risk profiles so that corrective action programs are instituted in a timely and constructive manner.”

Defaults on commercial real estate loans totaled $110 billion, or 6 percent of all such loans, in the second quarter. That’s 11 times the level in the fourth quarter of 2006 when the guidelines were released. Defaults may rise to $170 billion by the fourth quarter of 2010.

The risks are greater for community banks with assets of $10 billion or less because commercial real estate loans make up a bigger percentage of their business. Smaller banks don’t have the capital to compete with large banks for mortgages and consumer loans, so they turn to local-market lending, where they have an advantage.

Along with the OCC and the Federal Reserve, the FDIC in 2006 set a threshold -- 300% of a bank’s capital -- for safe levels of commercial real estate loans. The guidance was aimed at helping regulators identify banks with high loan concentrations that warranted greater supervisory scrutiny.

At the time, smaller and mid-sized banks opposed the guidelines. Bankers said they feared federal examiners would treat the thresholds as absolute limits, threatening a lucrative business for community lenders.

The regulators said the thresholds were not limits and that federal bank examiners would use the guidelines to identify lenders with risky levels of such loans.

The FDIC reiterated the importance of strong capital and risk-management practices for banks with high concentrations of commercial real-estate loans in a March 2008 letter.

“The supervisory process has to have more consistency in the good times and not just in the bad times,” said John Bovenzi, FDIC chief operating officer until this year. “It’s historically been harder to show effectively that changes need to be made when times are good.”

A surge in bank closings pushed the FDIC deposit insurance fund, which pays the cost of unwinding failed institutions, into a deficit, requiring the FDIC to replenish the reserve without overburdening hobbled banks. Last month, it proposed that banks prepay three years of premiums to raise $45 billion.

Bair told a Senate subcommittee on Oct. 14 that bank failures will continue to rise, reaching a peak next year, while costing the fund $100 billion through 2013.

“We should have been more strict,” Joseph Smith, North Carolina’s bank commissioner and chairman of the Conference of State Bank Supervisors, said in a telephone interview. “Had we required the reduction of CRE lending, it would have been thought of as an intrusion by regulators into the businesses of banks and to the operations of local economies,” Smith said. “Yes, it would have been the right thing to do. It would have caused a firestorm then. That might have been better than a firestorm now.”