Managing CRE concentration risk through change

The most effective methods for addressing CRE concentration risk involve an integrated, holistic approach rather than a piecemeal effort that focuses only on the most urgent or critical concerns.

A holistic approach generally encompasses four principal steps:

• Validating CRE data. While CRE data is more widely accessible than in the past, lenders should examine their loan portfolio databases and verify that information is correctly classified. Errors in coding and data entry can present a distorted picture of CRE concentrations, and merger activity across different systems generally creates challenges in data aggregation. Processes and procedures for creating, entering, validating, and quality-checking data and coding should be well documented.
• Analyzing concentration risk. Senior management can carry out risk analyses on validated loan portfolio databases to expose both portfolio and loan sensitivities. Careful loan stratification helps management look at loan concentrations in a new light.
• Mitigating CRE risk. After analyzing CRE concentrations, senior management can establish policies and processes to monitor CRE loan performance closely and change the mix of the portfolio when appropriate. Senior management oversight of credit portfolio management is critical, as is having an effective management information system in place.
• Reporting to management and the board. The final step in the concentration risk management process is regularly reporting to the senior management and the board. Reporting should include updates on mitigation efforts for any identified concentrations. Financial services organizations with higher levels of CRE loan activity might consider investing in dashboard reporting systems.

Loan review plays an important role in CRE risk management

Developing and implementing a more dynamic loan review function helps provide management and the board additional information they would not get elsewhere.

In addition to monitoring for conventional red flags and signs of risk, an assertive and proactive loan review function also uses technology and additional sampling to identify portfolio themes and trends. The aggregation of data from the loan review process identifies unique or forming pockets of risk in a portfolio that might not be observed via other activities. As applications for artificial intelligence and machine learning grow, this role likely will continue to evolve.

The loan review function also points out whether management reporting lacks granularity or sufficient detail and identifies other forms of risk associated with appraisal quality and underwriting practices.

Stress-testing processes, whether implemented through regulatory requirements or a lender’s own initiatives, provide even more insights into CRE concentration risk. Additionally, customer segmentation and sensitivity analysis highlight the potential effects certain economic variables could have on the portfolio.

Tweaking a few key inputs reveals the sensitivity of models to various economic scenarios. But beyond this basic function, stress testing also helps facilitate discussions with executive management, board members, and regulators to develop a better understanding of the loan portfolio. It also helps identify better-performing borrowers and segments when seeking potential growth opportunities.

Portfolio- and loan-level stress testing looks different across lending organizations, but the important thing is to start somewhere and to have a road map to address how quickly stress events can evolve.

Crowe can help you determine best practices for future consistency

Having a CRE concentration risk management plan is one thing. Putting it into effective practice can be another.

With uncertainty in markets and potential gaps in staffing and experience, outside support can offer deep knowledge of the industry and assist in developing solutions. Crowe consultants can help you build a strategy that works now and can adapt to the future, introducing technology and processes that enable more timely and intuitive decision-making. Areas to consider include assisting with loan review, helping enhance your existing loan review function, consulting assistance with data quality, or consulting on CRE concentration and stress testing.

Crowe consultants can help you stay ahead of the curve in many areas. Your teams can achieve a better view into your CRE risk profile now and gain a more accurate picture of what concentrations might look like in the future.