Commercial Real Estate Lending - Office of the …

Version 2.0

Comptroller¡¯s Handbook

Safety and Soundness

Commercial

Real Estate Lending

Version 2.0, March 2022

Comptroller¡¯s Handbook

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Commercial Real Estate Lending

Version 2.0

Contents

Introduction ..............................................................................................................................1

Overview ....................................................................................................................... 1

Authority and Limits ............................................................................................... 2

Equity Investments in Real Estate .................................................................... 3

Real Estate Lending Standards and Interagency Guidelines for Real Estate

Lending ............................................................................................................. 4

CRE Industry, Property Types, and Loan Types .................................................... 4

Acquisition, Development, and Construction Loans ........................................ 5

Interest Reserves ............................................................................................... 7

Income-Producing CRE Loans ......................................................................... 9

High-Volatility CRE Loans .............................................................................. 9

Risks Associated With CRE Lending ......................................................................... 10

Credit Risk ............................................................................................................ 11

Construction Issues ......................................................................................... 11

Market Conditions .......................................................................................... 11

Concentration Risk.......................................................................................... 12

Regulatory Changes ........................................................................................ 12

Interest Rates................................................................................................... 12

Environmental Liability .................................................................................. 12

Interest Rate Risk .................................................................................................. 13

Liquidity Risk ....................................................................................................... 13

Operational Risk ................................................................................................... 14

Compliance Risk ................................................................................................... 15

Strategic Risk ........................................................................................................ 15

Reputation Risk..................................................................................................... 16

Price Risk .............................................................................................................. 16

Risk Management ..................................................................................................................17

Management and Board Oversight ............................................................................. 17

Strategic Planning ................................................................................................. 17

Governance Structure............................................................................................ 18

Management and Board Reports ........................................................................... 18

Loan Policies ............................................................................................................... 19

Loan Portfolio Management Considerations ........................................................ 20

Underwriting Standards ........................................................................................ 21

Acquisition, Development, and Construction Policies ................................... 22

Investor-Owned Residential Real Estate Lending Standards ......................... 25

Supervisory Loan-to-Value Limits ....................................................................... 26

Excluded Transactions .................................................................................... 27

Loans Exceeding Supervisory Loan-to-Value Ratio Limits ........................... 28

Exceptions to General Lending Policy ................................................................. 28

Underwriting Practices................................................................................................ 29

Analysis of Borrower¡¯s and Guarantor¡¯s Financial Condition ............................. 29

Underwriting Acquisition, Development, and Construction Loans...................... 30

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Construction Concerns .................................................................................... 31

Evaluating the Developer Borrower ............................................................... 32

Determining Project Feasibility ...................................................................... 32

Collateral Valuation for Acquisition, Development, and ............................... 36

Construction Loans ......................................................................................... 36

Underwriting Income-Producing CRE Loans ....................................................... 39

Loan Structure................................................................................................. 39

Covenants........................................................................................................ 41

Income-Generating Capacity of CRE ............................................................. 42

Debt-Service Coverage Ratio ......................................................................... 43

Debt Yield ....................................................................................................... 43

Value Analysis ................................................................................................ 43

Loan-to-Value Ratio ....................................................................................... 44

Credit Administration ................................................................................................. 44

Acquisition, Development, and Construction Credit Administration ................... 45

Monitoring Progress of Construction Projects ................................................ 45

Disbursement Processes .................................................................................. 48

Income-Producing Property Credit Administration .............................................. 49

Investor-Owned Residential Real Estate ........................................................ 50

File Documentation............................................................................................... 51

Risk-Rating CRE Loans .............................................................................................. 53

Analyzing Repayment Capacity of the Borrower ................................................. 53

Evaluating Guarantees .......................................................................................... 54

Assessing Collateral Values .................................................................................. 54

Other Considerations ............................................................................................ 55

Risk-Rating Investor-Owned Residential Real Estate Loans ............................... 57

Classification of CRE Loans................................................................................. 57

Special Mention .............................................................................................. 58

Substandard ..................................................................................................... 58

Doubtful .......................................................................................................... 59

Loss ................................................................................................................. 60

Appraisals and Evaluations ......................................................................................... 60

Appraisal and Evaluation Program ....................................................................... 63

Appraisal and Evaluation Reviews ....................................................................... 64

Environmental Risk Management............................................................................... 65

Loan Workouts and Restructures ................................................................................ 68

Accrual Status ....................................................................................................... 69

Troubled Debt Restructurings ............................................................................... 71

Allowance for Credit Losses................................................................................. 71

Foreclosure............................................................................................................ 71

Concentration Risk Management ................................................................................ 71

Key Elements for CRE Concentration Risk Management .................................... 73

Control Systems .......................................................................................................... 73

Credit Risk Review ............................................................................................... 74

Internal Audit ........................................................................................................ 74

Third-Party Risk Management.............................................................................. 75

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Examination Procedures .......................................................................................................76

Scope ..................................................................................................................... 76

Quantity of Risk..................................................................................................... 79

Quality of Risk Management................................................................................. 85

Policies ............................................................................................................ 85

Processes ......................................................................................................... 87

Personnel ......................................................................................................... 89

Control Systems .............................................................................................. 90

Conclusions ........................................................................................................... 92

Internal Control Questionnaire .............................................................................. 95

Verification Procedures ....................................................................................... 109

Appendixes............................................................................................................................111

Appendix A: Quantity of Credit Risk Indicators ................................................. 111

Appendix B: Quality of Credit Risk Management Indicators ............................. 113

Appendix C: Supervisory Loan-to-Value Limits ................................................ 116

Appendix D: Underwriting Considerations by Property Type ............................ 119

Appendix E: Appraisal Review Worksheet ......................................................... 132

Appendix F: Evaluation Review Worksheet ....................................................... 136

Appendix G: Glossary ......................................................................................... 137

Appendix H: Abbreviations ................................................................................. 143

References .............................................................................................................................144

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Introduction

The Office of the Comptroller of the Currency¡¯s (OCC) Comptroller¡¯s Handbook booklet,

¡°Commercial Real Estate Lending,¡± is prepared for use by OCC examiners in connection

with their examination and supervision of national banks, federal savings associations (FSA),

and federal branches and agencies of foreign banking organizations (collectively, banks).

Each bank is different and may present specific risks and issues. Accordingly, examiners

should apply the information in this booklet consistent with each bank¡¯s individual

circumstances. When it is necessary to distinguish between them, national banks and FSAs

and covered savings associations (CSA) are referred to separately.1

For purposes of this booklet, commercial real estate (CRE) lending2 comprises

acquisition, development, and construction (ADC) lending and the financing of incomeproducing real estate. Income-producing real estate comprises real estate held for lease to

third parties and nonresidential real estate that is occupied by its owner or a related party.

This booklet addresses the risks inherent in CRE lending, risks unique to specific CRE

lending activities and property types, and prudent risk management. This booklet includes

expanded examination procedures for examiners to use when a bank¡¯s CRE lending activities

warrant review beyond the core assessments in the ¡°Community Bank Supervision,¡± ¡°Federal

Branches and Agencies Supervision,¡± and ¡°Large Bank Supervision¡± booklets of the

Comptroller¡¯s Handbook. This booklet also includes an internal control questionnaire and

verification procedures to further support the supervision process.

Overview

CRE lending is an important line of business for the banking industry, and CRE activities

contribute significantly to the U.S. economy. Many banks rely on revenue from this business

to grow and prosper. Imprudent risk-taking and inadequate risk management, particularly

during periods of rapid economic growth, can lead to significant levels of problem assets and

loan losses and can contribute to bank failures.

One of the key elements of risk in this type of lending is the cyclical nature of real estate

markets. As markets peak and decline, banks with large concentrations of CRE loans can

suffer considerable distress. Although the banking industry cannot accurately predict or

control the timing of the real estate business cycle, banks that consistently engage in prudent

risk management practices can more effectively manage risk from CRE lending and keep

Generally, references to ¡°national banks¡± throughout this booklet also apply to federal branches and agencies

of foreign banking organizations unless otherwise specified. Refer to the ¡°Federal Branches and Agencies

Supervision¡± booklet of the Comptroller¡¯s Handbook for more information regarding applicability of laws,

regulations, and guidance to federal branches and agencies. Certain FSAs may elect to operate as CSAs. For

more information, refer to OCC Bulletin 2019-31, ¡°Covered Savings Association Implementation: Covered

Savings Associations.¡±

1

Terms that are boldfaced on first mention in this booklet are defined in appendix G, ¡°Glossary,¡± of this

booklet.

2

Comptroller¡¯s Handbook

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Commercial Real Estate Lending

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