Managing Commercial Real Estate Concentrations

1. Managing Commercial Real Estate Concentrations AaSys User Group Tuesday, December 8, 2009

2. About the Presenter Michelle Lucci, CRCM & CAMS Risk Management Consultant, Commercial Real Estate Banker’s Toolbox, Inc. • Former Compliance Officer at Valrico State Bank • Director of the Suncoast Compliance Association • Former FDIC dual-commissioned examiner for 9 years • Published author/speaker on CRE • Former Customer of Banker’s Toolbox

3. Agenda • The Banking Crisis • Material Loss Review • Enforcement Actions • Preparing for CRE Examinations • Stress Testing • Integrating the Results into your Risk Management Program

4. Company Overview • Banker's Toolbox is a market leader in: • anti-money laundering compliance; • fraud loss prevention; • wire automation; • and loan risk management • for banks and credit unions nationwide.

5. About Us • Founded by former bankers • Privately-held corporation/100% owned by employees • ~60 Employees • No foreign outsourcing of services or programming • Over 3,000 bankers use our products daily across 700 enterprise installations in 45 states. • Asset ranges from de novo to $100B

7. The Banking Crisis Note: Size of the circles is based on the value of assets at time of failure. Source: http://s.wsj.net/public/resources/documents/info-Failed_Banks-sort.html

8. CRE in Recent Headlines Commercial RE risk looms for local banks Commercial Real Estate – The Next Shoe to Drop Slow recovery ahead for real estate Why the U.S. Commercial Real Estate Market Will Collapse,... Commercial real estate may be next big woe

9. Source:www.fdic.gov Bank Failures - Florida

10. Bank Failures - Georgia Source:www.fdic.gov

11. What is a Material Loss Review? Essentially it’s an autopsy that details what went wrong and what could have been done to prevent the failure. Source: http://www.fdicig.gov/MLR.shtml Material Loss Reviews

12. Material Loss Reviews Why The Audit is Done: Section 38(k) of the Federal Deposit Insurance Act states that when the Deposit Insurance Fund incurs a material loss with respect to an insured depository institution, the inspector general of the appropriate Federal banking agency shall make a written report to that agency reviewing the agency's supervision of the institution (including the agency's implementation of prompt corrective action provisions of section 38), which shall ascertain why the institution's problems resulted in a material loss to the Deposit Insurance Fund; and make recommendations for preventing any such loss in the future. A loss is material if it exceeds the greater of $25 million or 2 percent of an institution's total assets at the time the FDIC was appointed receiver. Reports are required six months after the material loss becomes apparent.

13. Material Loss Reviews Findings: Report No. AUD-09-011 May 2009 Material Loss Review of Freedom Bank, Bradenton, Florida • FB failed primarily due to bank management’s aggressive pursuit of asset growth concentrated in high-risk CRE loans with inadequate loan underwriting and a lack of other loan portfolio and risk management controls. • Source: http://www.fdicig.gov/reports09/09-011.pdf

14. Regulatory Enforcement Actions Peoples National Bank Colorado Springs, CO 8/27/09 Article IV COMMERCIAL REAL ESTATE RISK MANAGEMENT (d) portfolio-level multi-factor stress testing and/or sensitivity analysis on homogeneous pools of loans (e.g., HELOC, undeveloped land, office space) to quantify the impact of changing economic conditions on asset quality, earnings, and capital;

15. Regulatory Enforcement Actions Western Commercial Bank Woodland Hills, CA FDIC-09-370b; Issued 9/18/09 Within 60 days from the effective date of this ORDER, the Bank shall revise, adopt, and implement a plan requiring the prudent diversification of the Bank’s loan portfolio. Such plan shall include specific goals, actions and time frames for improving the Bank’s monitoring and limitation of its concentrations of credit. Such plan shall include, but not be limited to: (j) the establishment of formalized portfolio stress testing to better quantify, monitor, and address the risk to the Bank resulting from changing economic and market conditions.

16. Regulatory Enforcement Actions Los Padres Bank Western, CA WN-09-031; 10/14/2009 Concentrations Risk Management Policy By November 30,2009, the Board shall adopt a Concentrations Risk Management Policy that provides for the assessment, monitoring, and control of the potential concentrations risks for all assets other than conforming Single Family Residential (SFR) loans and for all funding sources, including, but not limited to, brokered deposits, uninsured deposits, Federal Home Loan Bank advances, and other borrowings. The Concentrations Risk Management Policy, at a minimum, shall address: (f) the requirement of stress tests or sensitivity analyses of the identified concentrations and portfolio segments with common risk characteristics, over specific time periods, to quantify the impact of changing economic scenarios on asset quality, earnings, and capital conditions, including, but not limited to, those affecting certain relevant industries or sectors on asset quality, earnings, and capital;

17. Regulatory Guidance Joint Press Release • December 12, 2006 • Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices • Financial Institution Letters • FIL-22-2008 March 17, 2008 • Managing Commercial Real Estate Concentrations in a Challenging Environment

18. Preparing For CRE Examinations • Classify or segment your portfolio • Know the current value of your holdings. • Stress test your portfolio. “Preparing for CRE Examinations” Click here to view the full article written by Michelle Lucci, CRCM, CAMS and published in the September 2009 issue of Community Banker magazine.

20. Step 1. Classify & Segment Your Portfolio • Property types • Borrower or collateral city/zip • Business type • DSCR • LTV • Branch or loan officer

21. Step 1. Classify & Segment Your Portfolio Identify and Investigate Risky Segments

22. Step 2. Know the CurrentValue of your Holdings The Moody’s/REAL All Property Type Aggregate Index fell to 109.61 in September 2009, representing a 3.9% decline from a month earlier. Commercial property prices have now fallen 42% from their peak in October 2007. Prices have fallen 37% from one year ago and 42% from two years ago. SOURCE: Moody’s/REAL Commercial Property Price Indices, November 2009

23. Step 3. Stress Testing The 3 Methods: Antiquated Report Writer Automated

24. Step 3. Stress Testing • Antiquated - Enter massive amounts of data into Excel and hope and worry that the data is constantly updated and accurate or your reports will be full of errors. • How much time on task are you willing to devote to this project?

25. Antiquated: Excel Spreadsheet

26. Antiquated: Excel Spreadsheet • Requires CONSTANT data input and maintenance • Results are PER LOAN BASIS ONLY – not portfolio level

27. Step 3. Stress Testing • Report Writers - Reports can be run on a portfolio wide basis. However, requires massive amount of data entry/maintenance, such as the Net Operating Income; Interest Rate; Capitalization Rate; Appraisal Value and Date. • This data is considered “static” in that it can only be updated manually. • Big concern – am I stress testing a loan with an appraisal from 2007 with a loan and appraisal from the current market? Will my results have any value?

28. Step 3. Stress Testing 3. Automated - Using a software model that has the ability to derive values, such as the Net Operating Income, and has the ability to apply modeling techniques update property values.

29. Automated Stress Testing Commercial Real Estate Loan Stress Test

30. Web Based Technology No Implementation, Software or Hardware Required Heit Data Center, Denver CO

31. Determining Income Current Cap Rate Net Operating Income Current or Implied Property Value

32. Cap Rate Trend Cap Rate + Date Implied Cap Rate Trend Or Actual Cap Rate Or Implied Cap Rate Trend

35. Crest 2.0.1.1 for bktb_MyBank HomeAdministrationSite MapLog Out Crest Welcome admin! Administration Business Settings Business Settings Stress Factors Stress Factors allow you to apply stress to your loan portfolios. Changes to the Potential Gross Income, Interest Rate, Vacancy Rate, Expenses and Cap Rate help determine the risk within your portfolios. Risk Ratings Risk Ratings are the loss factor ranges determined by your institution. Property Value Trends Property Value Trends allow you to apply current market value trends to outdated collateral appraisal values to keep them up-to-date. Cap Rate Trends Cap Rate Trends allow you to apply current cap rate trends to outdated cap rates for Commercial Real Estate with Rental Income loans to keep them up-to-date.

36. Crest 2.0.1.1 for bktb_MyBank HomeAdministrationSite MapLog Out Crest Assign Portfolio Welcome admin! HomePrint ReportsStress Test Report Details Select a portfolio to stress test Report Details: CRE w/ Rental Income Q1 2009 Printer FriendlyHelp All Loans (129 loans) Save Cancel Loan Category Title: CRE w/ Rental Income Q2 2009 CRE with Rental Income(118 loans) Assign… Portfolio: (Unassigned) As Of Date: 1/1/2008 1/1/2008 Zip Code Individually Stressed Loans Settings Printing Options Report Type Property Type Basic Stress Test Apartments(34 loans) All loans get the same stress. Retail(84 loans) Advanced Stress Test Define different stresses by segmentations. CRE Construction(11 loans) Combined Report Second segmentation: Define stress for individual segments using saved Stress Test settings. Cancel

37. Ability to perform a multi-variable stress test on the following factors: Net Operating Income Business Income Collateral Value Interest Rate – Fixed Rate & Variable Stress Testing

38. Set Customized Stress Factors Nobody knows your customers and community better than you do.

39. Setting Stress Factors

40. CREST 2.0.1.1 for bktb_MyBank HomeAdministrationSite MapLog Out Crest Welcome admin! AdministrationBusiness SettingsStress Factors Q1 2009 Apt Stress Mild Stress Factor Details: Q1 2009 Apt Stress Mild Printer FriendlyHelp Save Stress Calculator Cancel Basic Advanced Stress Title: Q1 2009 Apt Stress Mild Debt Payment: Fixed Rate: % 1 Decrease Amount % Variable Rate: % Income: Borrower’s Income: % 5 Decrease Amount % NOI from income property: % 5 Decrease Amount % NOI from farmland: % Collateral Value: Income property: % 5 Decrease Amount % Farmland: % Non-income property: % 5 Decrease Amount % Construction: % 5 Decrease Amount % Stock: % 5 Decrease Amount % UCC: % Auto: % Others: %

41. Data Integrity Through Automated Data Scrubbing

42. Crest 2.0.1.1 for bktb_MyBank HomeAdministrationSite MapLog Out Crest Welcome admin! HomePrint ReportsStress Test Report Details Report Details: CRE w/ Rental Income Q1 2009 Printer FriendlyHelp Save Cancel Title: CRE w/ Rental Income Q2 2009 My CRE Loans Assign… Portfolio: CRE with Rental Income As Of Date: 3/31/2009 Individually Stressed Loans Settings - Basic Stress Test Printing Options Report Type + Add Loan Note Number Borrower Name Outstanding Balance Mild Stress Severe Stress West Side Properties – Mild – … West Side Properties – Severe… 2347643 $7,510,127.01 Bay View Complex Subject is located on the NW corner of Bloomingdale and SR 60. The complex is fully rented with long-term leases at MV. Secondary source of repayment is the personal guarantee of Mr. Hal Lanford whose most recent PFS, dated 3/31/09, details NW of $9.8 Million with liquid assets of $1.5 Million. West Side Properties – Mild – … West Side Properties – Severe… Highlight Park Center 3843743 $3,701,146.54 Subject is located at the intersection of US301 and River Road. The shopping center has several franchise stores and is anchored by Giant grocery store. There are currently two vacancies which are being actively marketed. The loan is not designated as a Watch List credit at this time but will be closely monitored. Mr. Hal Lanford also guarantees this loan. Refer to details on note 2347643. + Add Loan

43. Portfolio Detail: CRE with Rental Income Portfolio full name: All Loans > CRE with Rental Income STRESS TEST RESULT Overview LTV DSCR

44. LTV DSCR

45. Segmentation: CRE with Rental Income > Property Type By Property Type Segment LTV DSCR No Stress No Stress Apartments Outstanding Balance: $84,987,041 Mild Mild Severe Severe No Stress No Stress Retail Outstanding Balance: $63,065,727 Mild Mild Severe Severe

46. Built-In Training

47. Integrating the Results into your Risk Management Program Management Letter View a sample management letter. Click Here (Open PDF document)

48. Pricing

49. Thank You!