The FDIC 2024 Risk Review noted that “risk ratings may see a deterioration as a result of the refinancing of commercial real estate (CRE) loans.”1 The rising trend in delinquencies and lower occupancy in certain sectors, coupled with softening collateral values, could weaken CRE loan portfolios, particularly from loans coming due during this period of higher interest rates.
Borrowers could face difficulties refinancing properties due to higher borrowing costs, which may affect repayment capacity and lower collateral values—two essential components considered by lenders.2 With an estimated $1.6 trillion in CRE loans maturing between 2024 and 2026, accurate risk ratings are instrumental in managing current portfolio risks while helping develop strategies for loan growth in asset classes preferred by your institution.
In fact, the Office of the Comptroller of the Currency (OCC) Semiannual Spring Risk Perspective from the National Risk Committee reported that “it is crucial that banks establish an appropriate risk culture that identifies potential risk, particularly before times of stress. The ability to proactively understand and respond to potential increased credit risk during times of stress remains a prudent resilience-planning component. Recognizing concentrations early and developing effective strategies for managing concentration risk enhance financial resilience.”3 The OCC indicated that commercial credit risk remains moderate although it shows signs of increasing.
Early detection and timely monitoring and analysis of credits is critical to accurately risk rating loans and borrowers. This includes collecting and reviewing required financial information in accordance with loan agreements and developing a plan of action based on anticipated events, updated forecasts, and actual performance.
A best practice to consider is to align the intended source of repayment with the actual source of repayment and document any changes with timely file updates. If the intended source of repayment is no longer viable or does not meet bank policies, analyze and re-grade accordingly. If you are “shifting” grade justifications, there is a clearly defined weakness. Recent conversations with loan review clients have indicated additional scrutiny from bank regulators on accurate risk rating and increasing downgrades from regulators.
In closing, identifying weaknesses and properly risk rating credits is a focus of regulatory exams and a proactive, transparent approach may be a key factor in a successful exam.
The loan review team at Forvis Mazars is comprised of over 50 credit professionals with an average of 25 years of credit experience. Working with over 400 institutions across the country provides us with unique insights, knowledge, and data. Data obtained during our loan reviews indicate an increase in the average classified loans to total loans ratio of 22 basis points from year-end 2023 through July 31, 2024. If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.