CRE Credit Expansion Raises Portfolio Concentrations

Commercial real estate (CRE) lending has come to be recognized as a highly cyclical business. Waves of construction and growth in credit to support CRE investment often have been followed by gluts of commercial space, rising vacancies, and sometimes severe credit problems arising from the sector. During the last broad CRE credit cycle, collapsing property values in the southwestern United States and New England contributed to many of the more than 2,000 failures of institutions insured by the Federal Deposit Insurance Corporation (FDIC) that occurred between 1980 and 1993. From this experience, one could make the case that CRE and construction and development (C&D) lending are among the riskiest of asset classes over the complete cycle.

Much has changed since the last broad CRE credit cycle. The volatility of the cycle may have been dampened by more and better structures to bring capital market financing to CRE, including commercial mortgage-backed securities (CMBS) and real estate investment trusts (REITs), better market data available to all participants, and relatively improved underwriting standards. However, FDIC-insured institutions continue to face risks related to the CRE credit cycle. CRE loan concentrations at FDIC-insured financial institutions now exceed levels seen in the last cycle. With so much at stake, it is important to understand the nature and stages of the CRE credit cycle.