Regulators view banks with CRE and construction concentrations as higher risk for a good reason: History shows that institutions with these concentrations were more prone to failure during periods of economic stress, such as the 2008 Global Financial Crisis and the real estate downturn of the early 1990s. The data is undeniable in that regard.
Additionally, some banks with CRE concentrations have operated under the radar for quite some time. Whether they developed their concentration post-pandemic or were too small in asset size to capture regulatory attention, many of these banks lack the capital planning and risk management infrastructure expected in today's regulatory landscape.
However, not all aspects of CRE concentration are negative. In fact, the benefits often outweigh the risks. Banks specializing in CRE lending typically develop deep expertise, translating into superior risk management. Their familiarity with local markets and specific lending niches allows them to make well-informed "go or no-go" decisions. For example, a bank specializing in bridge loans for skilled nursing facilities will be adept at navigating the complexities of HUD financing, as well as the intricacies of Medicare and Medicaid, which directly influence occupancy and rental rates.
The Minneapolis-based company said third-quarter average total loans slipped 1% from a year earlier. Still, it remains focused on organic expansion and averse to bank acquisitions.
Specialization also fosters infrastructure investment, unlocking economies of scale. Many banks with the highest returns on assets and lowest efficiency ratios in the industry have CRE concentrations.
The push for diversification isn't always the optimal path. After the 2008 financial crisis, community banks with less than $10 billion in assets experienced much higher loss rates on commercial and industrial loans than on nonowner-occupied CRE loans. Business lending is far more complex than CRE lending, often requiring expertise in specific industries and systems to track and manage soft collateral like accounts receivable and inventory.
Warren Buffet once said, "Diversification is protection against ignorance. It makes little sense if you know what you're doing."
There's no denying that CRE concentrations carry additional risks and heightened expectations. But the conversation needs balance, with more recognition of the strengths and advantages that come with focused expertise. Instead of discouraging these banks, we should appreciate those that choose to "stick to their knitting" and leverage their specialization to drive success.
