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This file was generated by Descript 

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Samantha: Hello,this is Samantha Shares.

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This episode covers an advisory Letter
issued by the F D I C on Managing

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Commercial Real Estate Concentrations
in a Challenging Economic Environment.

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These principles apply to all
financial institutions which

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is why we are sharing it here.

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Both were issued December eighteenth.

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The following is an audio version of
that advisory and the press release.

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This podcast is educational
and is not legal advice.

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We are sponsored by Credit Union
Exam Solutions Incorporated, whose

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team has over two hundred and
Forty years of National Credit

00:00:34.082 --> 00:00:36.032
Union  Administration experience.

00:00:36.462 --> 00:00:40.112
We assist our clients with N C
U A so they save time and money.

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If you are worried about a recent,
upcoming or in process N C U A

00:00:44.402 --> 00:00:48.732
examination, reach out to learn how they
can assist at Mark Treichel DOT COM.

00:00:49.012 --> 00:00:53.382
Also check out our other podcast called
With Flying Colors where we provide tips

00:00:53.382 --> 00:00:55.972
on how to achieve success with N C U A.

00:00:56.414 --> 00:00:57.894
And now the advisory letter.

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Summary:

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The F D I C is issuing this advisory
to reemphasize the importance of strong

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capital, appropriate Credit loss allowance
levels, and robust Credit risk-management

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practices for institutions with commercial
real estate (C R E) concentrations.

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It also conveys several key risk
management practices for institutions

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to consider in managing C R E
loan concentrations in the current

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challenging economic environment.

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Additionally, the advisory reemphasizes
the importance of effectively managing

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liquidity and funding risks, which can
compound lending risks, particularly

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for C R E-concentrated institutions.

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This advisory replaces the TWO THOUSAND
EIGHT advisory: Managing Commercial

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Real Estate Concentrations in a
Challenging Environment (issued March

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SEVENTEENTH , TWO THOUSAND EIGHT).

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Statement of Applicability: The
contents of, and material referenced

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in, this letter apply to all F D I
C-supervised financial institutions.

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Editorial note: N C U A examiners often
refer credit unions to F D I C guidance.

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Highlights:

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The F D I C is issuing this letter to
reemphasize the importance of strong

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capital and credit loss allowance
levels, as well as robust credit risk

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management practices, for institutions
with concentrated C R E exposures.

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Institutions with significant C R E
concentrations are advised to consider

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the risk management principles discussed
in the joint Guidance on Concentrations

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in Commercial Real Estate Lending, Sound
Risk Management Practices (issued December

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6, two thousand and six6), and the
Interagency Policy Statement on Allowances

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for credit Losses (Revised April twenty
seven, two thousand and twenty three).

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The advisory also identifies key
risk-management actions for financial

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institutions with significant C R
E concentrations to manage through

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changes in market conditions:

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Maintain strong capital levels,

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Ensure that credit loss
allowances are appropriate,

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Manage construction and development (C
AND D) and C R E loan portfolios closely,

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Maintain updated financial
and analytical information,

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Bolster the loan workout
infrastructure, and

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Maintain adequate liquidity
and diverse funding sources.

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Institutions are encouraged to continue
making C R E credit available in their

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communities using prudent lending
standards that rely on strong underwriting

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and loan administration practices.

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The full text of the letter follows.

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Managing Commercial Real
Estate Concentrations in a

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Challenging Economic Environment

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This advisory to insured state
non-member banks and savings associations

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reemphasizes the importance of strong
capital, appropriate Credit loss allowance

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levels, and robust Credit risk-management
practices when managing commercial

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real estate (C R E) concentrations.

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This advisory replaces an advisory
issued in TWO THOUSAND EIGHT1 that

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emphasized these same points during a
time when C R E market conditions had

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weakened, most notably in the construction
and development (C AND D) sector.

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This advisory conveys several key
risk management practices for F D I

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C-supervised institutions to consider in
managing C R E loan concentrations in the

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current challenging economic environment.

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The advisory also continues to emphasize
the importance of effectively managing

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liquidity and funding risks, which can
compound lending risks, particularly

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for C R E- concentrated institutions.

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This advisory does not create
new risk management principles;

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however, it does update and build
upon previously issued guidance.

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Previous Challenging Economic Environments

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The F D I C recognizes that financial
institutions play a critical role in

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the economic vitality of the communities
they serve by providing Credit for

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businesses, often for C R E purposes,
including real estate development.

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However, concentrations in C
R E lending add dimensions of

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risk that warrant attention.

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C R E lending concentrations, combined
with weak risk management practices,

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contributed significantly to past asset
quality problems and bank failures.

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One example is the banking and thrift
crisis of the 1980s and early 1990s.2

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Bank decisions to loosen C R E lending
standards during the 1980s were based

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primarily on the assumption that real
estate values (collateral values)

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would continue to rise in the future
as they had in the then recent past.

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Another example is the banking crisis
of TWO THOUSAND EIGHT to twenty thirteen

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which impacted the many financial
institutions that had greatly increased

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their holdings of, and concentrations
in, in particular, loans to finance

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the development and construction of
real estate (C AND D loans) in the

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period leading up to the crisis.

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In these crises, when C R E markets
deteriorated, poor management

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of C R E lending concentrations
led to increased Credit losses.

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Further, many C R E- concentrated
institutions that failed also relied

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on funding sources other than stable
deposits and had lower levels of capital.

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Current Challenging Economic
Environment and Real Estate Conditions

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Recent weaknesses in the current
economic environment and in fundamentals

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related to various C R E sectors have
increased the F D I C’s overall concern

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for state nonmember institutions
with concentrations of C R E loans.

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C R E market and lending conditions
have been significantly influenced by

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governmental and societal responses to the
pandemic, rapidly rising interest rates,

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and the prolonged inverted yield curve.

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Also, C R E investment property
capitalization rates have not kept

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pace with recent rapid increase
in long-term interest rates, which

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leads to concerns about general
over-valuation of underlying collateral.

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C R E vacancy rates are rising,
most notably in the office

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sector, but also in multi-family.

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Office vacancy rates are affected
by the demand for traditional

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office space, which has slowed due
to the popularity of remote work.

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Office attendance is approximately
50 percent of its pre-pandemic level.

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In addition to large amounts of
available space, high levels of office

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loans and office leases are maturing
or expiring in the next few years.

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The multi-family sector vacancy rate
is also high in some markets, due

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in part to potential overbuilding.

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Rapid absorption of multi-family
space experienced in twenty twenty

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one has since slowed, while the pace
of new construction remains brisk.

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Refinancing office and multi-family loans
could be challenging in an environment

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of pressured rent growth, higher interest
rates, and lower property values,

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particularly for those institutions
with C R E concentrations in areas with

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surplus office and multi-family space.

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The F D I C’s concern also extends to
the subset of banks with elevated C AND

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D concentrations, which subset has risen
in recent quarters, but remains well

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below the two thousand and seven peak.

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Banks with significant exposure to
C AND D loans had substantial Credit

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losses during the TWO THOUSAND
EIGHT-two thousand thirteen banking

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crisis, and banks currently engaged
in C AND D lending could be affected

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by weaknesses in the current economic
environment and real estate fundamentals.

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The F D I C continues to be concerned
that institutions with concentrated C

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R E exposures may be vulnerable to real
estate downturns and is reminding such

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F D I C-supervised institutions of the
importance of ensuring that Credit risk

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management practices are strong, reliable
funding sources are in place and liquidity

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contingency plans are robust, property
valuation policies and procedures capture

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changes to property values, capital and
allowance for Credit losses (A C L) levels

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are appropriate, and workout processes
are well-defined and ready to be deployed.

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It is strongly recommended that, as market
conditions warrant, institutions with C R

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E concentrations (particularly in office
lending) increase capital to provide

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ample protection from unexpected losses
if market conditions deteriorate further.

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Managing C R E Concentrations

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In December two thousand six, the F D
I C and the other prudential regulators

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issued Concentrations in Commercial
Real Estate Lending, Sound Risk

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Management Practices (C R E Guidance).

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Institutions with significant C R
E concentrations are reminded that

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strong risk management, governance,
capital, and appropriate ACL levels

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are needed to help mitigate risks.

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Institutions with overall Credit risk
management processes that reflect

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consideration of the principles of
the two thousand six C R E Guidance

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are better positioned to manage
through adverse economic environments.

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The principles in the two thousand
six C R E guidance remain relevant,

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particularly in challenging economic
environments, and particularly for

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institutions engaged in significant C R
E lending strategies to help them remain

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healthy and profitable while continuing to
serve the Credit needs of the community.

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The F D I C has identified six key
risk-management actions to help

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institutions with significant C AND
D and C R E concentrations manage

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through changes in market conditions:

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Maintain Strong Capital Levels

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Capital provides institutions with
protection against unexpected losses,

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particularly in stressed markets.

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Institutions with significant C AND
D and C R E exposures may require

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more capital because of uncertainty
about market conditions causing an

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elevated risk of unexpected losses.

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As market conditions warrant, proactive
directorates and management take steps

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to increase capital levels to support
significant C R E concentrations and

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mitigate the impact of potential loss.

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Maintenance of an appropriate level
of capital to protect an institution

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from unexpected losses related to
C AND D and C R E concentrations

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is an important consideration
when contemplating cash dividends.

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Ensure that Credit Loss
Allowances are Appropriate

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Institutions are expected to determine
their A C L’s in accordance with

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U S generally accepted accounting
principles (GAAP) and regulatory

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reporting instructions, relevant
supervisory guidance, their

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stated policies and procedures,
and management’s best judgment.

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Prudent Credit management includes
periodic, at least quarterly, analysis

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of the collectability of C R E and all
other exposures and maintenance of A

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C L’s at a level that is appropriate
to cover expected Credit losses on

00:11:11.299 --> 00:11:15.299
individually evaluated loans, as
well as expected Credit losses in

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the remainder of the loan portfolio.

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In reviewing their A C L methodology,
institutions with significant C AND D

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and C R E concentrations are advised
to consult recent supervisory guidance.

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In accordance with GAAP, management
should consider the effects of past

00:11:32.099 --> 00:11:36.099
events, current conditions, and reasonable
and supportable forecasts on the

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collectability of the institution’s loans.

00:11:38.099 --> 00:11:41.299
Specifically, GAAP requires management
to use relevant forward-looking

00:11:41.299 --> 00:11:44.899
information and expectations drawn from
reasonable and supportable forecasts

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when estimating expected Credit losses.

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While historical loss information
generally provides a basis for an

00:11:50.899 --> 00:11:54.499
institution’s assessment of expected
Credit losses, management should consider

00:11:54.499 --> 00:11:58.899
whether further adjustments to historical
loss information are needed to reflect

00:11:58.899 --> 00:12:03.299
the extent to which current conditions
and reasonable and supportable forecasts

00:12:03.299 --> 00:12:07.699
differ from the conditions that existed
during the historical loss period.

00:12:07.729 --> 00:12:11.619
Manage C AND D and C R E
Loan Portfolios Closely

00:12:12.018 --> 00:12:20.018
Consistent with Parts 3 6 4 and 3 6 5
of the F D I C Rules and Regulations and

00:12:20.018 --> 00:12:23.218
their appendices, institutions should
maintain prudent lending standards

00:12:23.218 --> 00:12:27.218
and Credit administration practices
that consider the risks of material

00:12:27.218 --> 00:12:30.418
C AND D and C R E concentrations.

00:12:30.418 --> 00:12:34.418
This includes management information
systems that provide the board and

00:12:34.418 --> 00:12:38.418
management with relevant data on
concentrations levels and related market

00:12:38.418 --> 00:12:42.018
conditions, including for concentration
or market segments, as appropriate.

00:12:42.108 --> 00:12:46.798
Portfolio and loan level stress tests or
sensitivity analysis can be an invaluable

00:12:46.798 --> 00:12:51.208
tool in identifying and quantifying the
impact of changing economic conditions

00:12:51.208 --> 00:12:55.598
and changing loan level fundamentals on
asset quality, earnings, and capital.

00:12:56.118 --> 00:12:59.888
Applying adverse scenarios while
conducting stress tests or sensitivity

00:12:59.888 --> 00:13:04.498
analysis helps banks adjust risk
management processes, capital planning,

00:13:04.498 --> 00:13:09.118
liquidity management, collateral valuation
processes, and workout procedures to

00:13:09.118 --> 00:13:13.038
prepare for Credit risk problems before
they impact earnings and capital.

00:13:13.408 --> 00:13:17.238
Additionally, appropriate risk
management practices include maintaining

00:13:17.238 --> 00:13:21.108
a strong Credit review and risk
rating system12 that identifies

00:13:21.108 --> 00:13:23.018
deteriorating Credit trends early.

00:13:23.528 --> 00:13:27.288
It is important for institutions to
effectively manage interest reserves

00:13:27.288 --> 00:13:31.668
and loan accommodations,14 reflecting
the borrower’s condition accurately in

00:13:31.668 --> 00:13:33.848
loan ratings and documented reviews.

00:13:34.258 --> 00:13:37.438
Maintain Updated Financial
and Analytical Information

00:13:37.885 --> 00:13:42.285
Prudent institutions with C R
E and/or C AND D concentrations

00:13:42.285 --> 00:13:45.485
maintain recent borrower financial
statements, including property cash

00:13:45.485 --> 00:13:49.485
flow statements, rent rolls, guarantor
personal statements, tax return data,

00:13:49.485 --> 00:13:53.485
and other income property performance
information to better understand their

00:13:53.485 --> 00:13:57.885
borrowers’ ability to repay and overall
financial condition and enable timely

00:13:57.885 --> 00:13:59.485
identification of adverse trends.

00:13:59.485 --> 00:14:02.685
Such institutions emphasize global
financial analysis of obligors,

00:14:02.685 --> 00:14:06.685
including in relation to pending loan
maturities and lease expirations,

00:14:06.685 --> 00:14:10.685
as well as the concentration of
individual property owners, builders,

00:14:10.685 --> 00:14:13.085
or developers in a loan portfolio.

00:14:13.085 --> 00:14:17.485
As real estate market and individual
property conditions change, it is

00:14:17.485 --> 00:14:21.485
important for management to consider
the continued relevance of appraisals

00:14:21.485 --> 00:14:25.885
and evaluations performed during prior
economic or market and interest rate

00:14:25.885 --> 00:14:29.085
conditions, and update collateral
valuation information as necessary.15

00:14:29.085 --> 00:14:32.285
Maintaining updated financial and
analytical information provides key

00:14:32.285 --> 00:14:36.685
inputs to foster meaningful stress testing
or scenario analysis described above.

00:14:36.785 --> 00:14:38.955
Bolster the Loan Workout Infrastructure

00:14:39.355 --> 00:14:43.355
Well prepared institutions ensure they
have sufficient staff and appropriate

00:14:43.355 --> 00:14:48.155
skill sets to properly manage an
increase in problem loans and workouts.

00:14:48.155 --> 00:14:52.155
Likewise, institutions that have a
ready network of legal, appraisal,

00:14:52.155 --> 00:14:55.755
real estate brokerage, and property
management professionals to handle

00:14:55.755 --> 00:14:59.755
additional prospective workouts are better
situated for more positive outcomes.

00:14:59.785 --> 00:15:03.125
Maintain Adequate Liquidity
and Diverse Funding Sources

00:15:03.494 --> 00:15:07.394
Since liquidity and funding risks may
be compounded in challenging interest

00:15:07.394 --> 00:15:11.354
rate and economic environments, it is
important for institutions to have a

00:15:11.354 --> 00:15:15.684
comprehensive management process for
identifying, measuring, monitoring, and

00:15:15.684 --> 00:15:17.864
controlling liquidity and funding risks.

00:15:18.424 --> 00:15:22.354
Recent industry events have underscored
risks related to relying on funding

00:15:22.354 --> 00:15:26.954
concentrations, such as high levels of
uninsured deposits, and the importance

00:15:26.954 --> 00:15:30.984
of robust liquidity risk management
and contingency funding planning.

00:15:31.404 --> 00:15:35.134
Institutions that have identified
appropriate levels of cash and cash

00:15:35.134 --> 00:15:39.184
equivalents, that have identified and
are able to use a stable and diverse

00:15:39.184 --> 00:15:43.194
range of funding mechanisms, and that
have identified and tested sources

00:15:43.194 --> 00:15:47.234
of contingent liquidity, including
establishing and testing access to

00:15:47.234 --> 00:15:51.114
the Federal Reserve Discount Window,
are better positioned to profitably

00:15:51.114 --> 00:15:53.484
support C R E concentrations.

00:15:53.858 --> 00:15:57.858
As with any asset exposure,
significant C R E concentrations

00:15:57.858 --> 00:16:02.258
can lead to losses and capital
deficiencies in a stressed environment.

00:16:02.258 --> 00:16:07.458
The F D I C’s examiners recognize the
challenges facing institutions in the

00:16:07.458 --> 00:16:13.058
current C R E environment, and will expect
each board of directors and management

00:16:13.058 --> 00:16:19.058
team to strive for strong capital and
appropriate A C L levels, and to implement

00:16:19.138 --> 00:16:21.478
robust Credit risk-management practices.

00:16:21.998 --> 00:16:26.928
Institutions are encouraged to continue
making C AND D and C R E Credit available

00:16:26.928 --> 00:16:31.358
in their communities using prudent lending
standards that rely on strong underwriting

00:16:31.358 --> 00:16:33.298
and loan administration practices.

00:16:33.848 --> 00:16:38.458
The Appendix includes selected F D I
C regulations, supervisory guidance,

00:16:38.688 --> 00:16:41.588
and other relevant information
for additional details about

00:16:41.588 --> 00:16:43.598
matters discussed in this advisory.

00:16:44.081 --> 00:16:48.371
Refer to the F D I C’s regulations,
supervisory guidance, and other

00:16:48.371 --> 00:16:52.551
information for additional details about
matters discussed in this Advisory.

00:16:53.010 --> 00:16:56.940
This concludes the F D I C  advisory
Letter on managing commercial

00:16:56.940 --> 00:17:00.460
real estate concentrations in a
challenging economic environment.

00:17:00.910 --> 00:17:05.550
F Y I, the co author of the NCU A's
Commercial loan rule is a member of our

00:17:05.550 --> 00:17:08.080
team at Credit Union Exam Solutions.

00:17:08.486 --> 00:17:12.566
If your Credit union could use assistance
with your exam, reach out to Mark Treichel

00:17:12.566 --> 00:17:15.276
on LinkedIn, or at mark Treichel dot com.

00:17:15.766 --> 00:17:18.446
This is Samantha Shares and
we Thank you for listening.