| 
Some members of the Federal Open Market Committee in July expressed concern that “smaller banks could be assuming significant risks in efforts to expand their CRE (commercial real estate) lending.”
This concern – that banks are amassing high concentrations of CRE loans while easing underwriting standards – is one regulators have repeated publicly since early 2016.
But the warnings have not dulled CRE growth or spooked community banks in Massachusetts, who continue to take advantage of low interest rates and a strengthening economy to bulk up their CRE portfolios.
“Over the last 18 months, there has been heightened awareness [by all regulators] of high commercial real estate concentration,” Terence McGinnis, commissioner of the Massachusetts Division of Banks, told Banker & Tradesman. “A high concentration in and itself is not bad if it is being managed appropriately. … Our banks have very strong capital and good liquidity.”
High CRE Concentrations
According to a federal interagency guidance, banks will draw intensified scrutiny if CRE loans (excluding owner-occupied loans) represent 300 percent or more of the institution’s total risk-based capital. Two of the state’s 10 largest community banks have exceeded this concentration amount, according to the FDIC.
The $3.5-billion asset Cambridge Savings Bank, which declined to comment for this article, had a CRE loan-to-risk-based-capital ratio of 356 percent. The $4.7-billion asset East Boston Savings Bank, which also declined to comment, had a ratio of 307 percent. Brookline Bank followed at 231 percent.
In addition, a recent regulatory filing showed that Brookline Bancorp, the parent company of Brookline Bank and several subsidiaries, increased its nonperforming assets by close to $6 million through the first six months of this year, largely from two commercial loans placed on nonaccrual.
In Massachusetts as a whole, the median ratio of commercial real estate loans divided by qualifying total capital in the first quarter of 2017, which included owner-occupied real estate, was slightly above 250 percent, up about 20 percent from a year ago.
Darryl Fess, president and CEO of Brookline Bank, said the company does not plan to slow down CRE loan origination. EBSB has grown total CRE loans by almost $370 million year-over-year.
Richard J. Gavegnano, chairman, president and CEO of Meridian Bancorp, the holding company of EBSB, said in a recent earnings report that “the continuing strength of our organic loan growth” is vital to the bank’s expanding presence in the Boston market.
More Than Concentration
It is not surprising to see community banks flocking to CRE loans, said Giuseppe “Joe” Femia, vice president and director of the CPA and consulting firm G.T. Reilly & Co., because the inventory for residential homes is low.
There is also not a lot of residential lending refinancing right now because interest rates have picked up slightly, meaning whomever was going to refinance has already done so, whereas the CRE space has been expanding due to the strong economy over the last few years, he said.
But high concentration alone does not set off the alarm.
McGinnis said risk management is a serious consideration – how detailed is a bank’s stress testing? Does the bank’s board know about the high CRE concentration? How is the bank funding its loans?
Another important measure, said Femia, is the underwriting process as community banks beef up there CRE portfolios – for example, whether the bank is getting 25 percent down or full guarantees from the business owners on the loans they originate.
While some of Brookline Bank’s ratios are getting high, Bill Mackenzie, executive vice president of commercial banking, points out that growing a CRE portfolio dramatically is not always so easy because there can be quite a high loan turnover rate.
A bank’s loan portfolio can essentially only grow by one-third to one-fifth of what it originates, he said, adding that Brookline is funding 60 percent of its current loans with core deposits.
Brookline Bank and EBSB are also planning to grow their core deposits. EBSB is one of the fastest growing banks in the state; it is opening new branches and making acquisitions, such as its recent purchase of Meetinghouse Bank.
Brookline has pledged to boost its commercial and industrial lending, which typically brings in deposits, and also raised $82 million in stock offerings in the second quarter.
The two banks also have solid overall credit quality.
Funding Loan Growth
Both Brookline Bank and EBSB had a higher volume of loans than deposits at the end of the second quarter, so they will be forced to grow deposits or increase their borrowings to boost loan growth.
Aside from new branches and acquisitions, growing deposits is difficult in this low-rate environment, leading some banks to turn to borrowings from the Federal Home Loan Bank.
EBSB has grown its FHLB advances to more than $474 million at the end of the second quarter, up more than $150 million from a year ago. Brookline Bank had reached more than $680 million in FHLB advances.
In fact, Brookline Bancorp notes in a recent regulatory filing that one of its risk factors is its ability to “decrease its reliance on FHLBB advances.”
“If banks are doing too many FHLB borrowings to help fund 30-year, fixed rate mortgage loans, that could be risky because rates could rise,” Femia said. “Rates have remained relatively low over the last several years, but there is always that fear in the banking industry that they may increase. … If a bank has too many real estate loans at a fixed-rate, this may be a red flag for the regulators.”
For instance, according to regulatory filings, although ESBS’s parent company Meridian Holding Corp. has mostly fixed-rate FHLB debt, it also has $85 million of FHLB variable rate advances that mature between 2020 and 2024.
If those borrowings are helping fund fixed-rate loans, that could be problematic down the line.
Femia said he understands why community banks in Massachusetts are pursuing CRE opportunities, given the demand in the region and low interest rates.
But CRE loan growth was probably better suited a year or two ago, he said, because the CRE and construction lending space is currently at a high point and the continued increase in values will be difficult to sustain at this pace. ■
