While estimates can vary based on what source you review, most banks have CRE loans in their portfolio — the largest loan type for nearly half of all banks. The upward trajectory of CRE loan delinquencies that began in Q4 2022 continued with elevated lending exposure throughout 2023.
Trends in 2024 continued to point toward increases in delinquencies in CRE due to decreased loan growth and continuing declines in occupancy. These trends indicate pressure on management of CRE lending and have resulted in heightened regulatory attention with an increased focus on internal loan reviews.
Your Recommended Response to CRE Lending Pressure in 2025
The FDIC, OCC, the Fed, and NCUA agree: An effective credit risk review function is critical to safe and sound operation. It helps financial institutions identify, evaluate, and address emerging risks associated with credit weakness. It also helps validate and adjust risk ratings before regulatory inspection.
Be On the Lookout: Red Flags & Factors in to Consider in CRE Loan Reviews
Some common characteristics of inadequate loan review and factors that contribute to CRE lending delinquencies and losses may include:
- Failure to review the entire borrower relationship, incomplete loan file data, outdated cash flow information, and lack of proof of liquidity
- Lack of market information, out-of-market lending, and purchase of loan participations
- Highly leveraged transactions and long gestation periods that allow market dynamics to change before a project’s completion
- Relatively low borrowing costs and the easy availability of credit
- Nonrecourse lending and legal structures that shield project sponsors from risk
New Regulations in Appraisal Industry May Improve Loan Quality
Another historical contributor to CRE lending delinquencies is the previously unregulated appraisal industry that often relied on inflated assumptions from inexperienced appraisers. Now, regulated appraisals and the requirement that banks establish an independent real estate evaluation are improving lending quality. For example, new loan-to-value (LTV) limits make institutions less vulnerable to market downturns because they require borrowers to have more tangible equity in the collateral real estate to cushion against declining values.
Updated Guidance
Updated guidance addresses concerns with and management of portfolio concentrations. It also recognizes that diversification can be achieved within CRE portfolios and differentiates risk by loan type. It targets CRE loans that use real estate-generated cash flow as the primary source of loan repayment, such as development and construction loans for which repayment depends on the sale of the property and property loans for which repayment depends on rental income.
You May Need Heightened Risk Management Practices If …
The guidance identifies financial institutions that may need heightened risk management practices commensurate with portfolio complexity as those with rapid CRE loan growth, concentrated exposure to certain types of CRE, or those approaching or exceeding at least one of the following supervisory criteria:
- Total loans reported on the Report of Condition for construction, land development, and other land represent 100% or more of the institution’s total capital.
- Total CRE loans represent 300% or more of the institution’s total capital and a 50% or higher increase in the outstanding balance of the institution’s CRE loan portfolio during the prior 36 months.
These banks will receive closer regulatory attention. Underscoring the importance of internal loan review, examiners will carefully consider the financial institution’s own analysis of its CRE portfolio, including:
- Portfolio diversification across property types and geographic location
- Underwriting standards
- Level of pre-sold units or other types of take-out commitments on construction loans
- Portfolio liquidity to sell or securitize exposures on the secondary market
Loan Review Best Practices
For a solid loan review analysis, look to outsourced third-party experts, an experienced in-house team that’s independent from lending and approval functions, or a combination of the two. No matter who conducts the analysis, complete documentation that supports loan review conclusions is essential.
People. Qualified loan review personnel should have experience in commercial lending and credit analysis, including the ability to review and understand borrower financial statements; in-depth knowledge of internal policies and state and federal regulations; and expertise establishing and managing reserves and problem loans.
Process. Ensure that there is a well-established process to maintain and update loan files to provide missing and stale documents, track credit downgrades, and analyze document exception patterns to identify and remediate process gaps, correct mistakes, and enhance employee training.
Portfolio. Individual loan reviews build the dataset for portfolio analyzation, enabling your institution to identify risks that should be monitored on an ongoing basis —before they become problems that result in delinquencies and losses. For example, human and AI-assisted evaluation of client relationships and borrowers’ business cycles, as well as financial forecasts and projected and actual changes in project completion and incoming-producing property leases can support analysis of borrowers’ cash flow changes that have the potential to increase delinquencies.
Empower your board with the right tools and expertise to navigate the complexities of CRE lending. To learn more about best practices and how we can support your institution in maintaining a safe and sound operation, contact your Rehmann advisor or Kevin Frank at [email protected] or 989.797.8346.
