COMMERCIAL REAL 

ESTATE LENDING

Banks Potentially 

Face Increased Risk; 

Regulators Generally 

Are Assessing Banks' 

Risk Management 

Practices

Report to Congressional Addressee

March 2018

GAO-18-245

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-18-245, a report to 

congressional addressee

March 2018

COMMERCIAL REAL ESTATE LENDING

Banks Potentially Face Increased Risk; Regulators 

Generally Are Assessing Banks’ Risk Management 

Practices

C

What GAO Found

While the commercial real estate (CRE) sector has recovered since the 2007–

2009 financial crisis, GAO’s trend and econometric analyses generally indicate 

that risk in CRE lending by banks has increased over the past several years. 

Since the early 2000s, community banks have tended toward providing CRE 

loans more than other kinds of loans. Indicators of CRE market conditions and 

loan performance have been improving since 2011. At the same time, GAO’s 

analyses of changes in CRE underwriting standards, property prices, and other 

data suggest that credit and concentration risks have increased in bank CRE 

lending. For example, the number of banks with relatively high CRE 

concentrations—measured by the ratio of a bank’s CRE loans to its total 

capital—has been increasing. In addition, commercial property prices have been 

increasing rapidly, and property valuations also have risen in recent years. 

Similarly, GAO’s predictive econometric models of CRE loan performance 

suggest that risk has increased, based largely on the simultaneous increase in 

bank CRE lending and CRE prices observed over the last several years, but is 

lower than the level associated with the 2007–2009 financial crisis.

Number of Banks with Commercial Real Estate Loans Representing 300 Percent or More of 

Their Total Capital, Based on Year-End Data, 2007–2017

GAO found that federal banking regulators subjected banks with relatively high 

CRE concentrations to greater supervisory scrutiny based on its review of a 

nongeneralizable sample of 54 bank examinations covering 40 banks done by 

the Federal Deposit Insurance Corporation, Board of Governors of the Federal 

Reserve System, and Office of the Comptroller of the Currency from 2013 

through 2016. Of the 54 examinations that GAO reviewed, 41 of them covered 

banks with relatively high CRE concentrations. In all of these examinations, 

regulators examined whether the banks had adequate risk management 

practices and capital to manage their CRE concentration risk. In 26 of the 41 

examinations, regulators did not find any risk management weaknesses. 

However, in 15 of the 41 examinations, regulators found the banks had 

weaknesses in one or more risk management areas, such as board and 

management oversight, management information systems, or underwriting. The 

regulators generally communicated their findings to the banks in the reports of 

examination and directed the banks to correct their risk management 

weaknesses. 

View GAO-18-245. For more information, 

contact Lawrance Evans at (202) 512-8678 or 

evansl@gao.gov.

Why GAO Did This Study

In 2006, federal banking regulators 

jointly issued guidance that described

their expectations for sound risk 

management practices for banks with 

CRE concentrations. The guidance 

includes two CRE thresholds that 

regulators use to identify banks that 

are potentially exposed to significant 

CRE concentration risk and could be 

subject to greater supervisory scrutiny.

Concentrations in CRE loans at U.S. 

banks have been steadily increasing—

raising safety and soundness 

concerns. In December 2015, the 

regulators jointly issued a public 

statement to remind banks of the 2006 

CRE guidance.

In light of the joint 2015 statement and 

GAO’s ongoing monitoring of 

regulatory efforts to identify and 

respond to emerging threats to the 

banking system, GAO examined (1) 

trends in the CRE lending market, 

including changes in risk, and (2) 

actions taken by regulators to help 

ensure that banks with CRE 

concentrations are effectively 

managing the related risks. To address 

these issues, GAO analyzed CRErelated data; reviewed agency policies 

and guidance; and reviewed a 

nongeneralizable sample of 54 bank 

examinations conducted from 2013 

through 2016 based on the banks’

CRE concentrations, total assets, 

primary regulator, and geographic 

location. GAO also interviewed officials

from the federal banking regulators.
Page i GAO-18-245 Commercial Real Estate Lending

Letter 1

Background 4

Credit and Other Risks Related to Bank CRE Lending Have 

Increased over the Past Several Years 10

Regulators Examined Risk Management Practices of Banks with 

CRE Concentrations 15

Agency Comments 22

Appendix I Objectives, Scope, and Methodology 24

Appendix II GAO Predictive Models of Aggregate Losses on Bank Commercial 

Real Estate Loans 28

Appendix III GAO Contact and Staff Acknowledgments 33

Figures

Figure 1: Bank Internal Control Areas for Managing Commercial 

Real Estate Concentration Risk Based on 2006 Guidance 7

Figure 2: Delinquency and Charge-off Rates on Bank Commercial 

Real Estate Loans from 2002 through Second Quarter of 

2017 11

Figure 3: Change in Underwriting Standards by Banks for 

Commercial Real Estate Properties from First Quarter of 

2002 through Second Quarter of 2017 12

Figure 4: Capitalization Rates on Commercial Real Estate 

Properties from January 2002 to September 2017 13

Figure 5: Number of Banks with Concentrations in Construction 

and Land Development and Total Commercial Real 

Estate Loans, First Quarter of 2007 through Second 

Quarter of 2017 14

Figure 6: Number of Sampled Examinations in Which Federal 

Banking Regulators Found a Commercial Real EstateRelated Risk Management Weakness in One or More of 

the Internal Control Areas 17

Figure 7: Historical Charge-offs from 2002–2017 (1 year moving 

average) with Predictive Model Forecast Comparison, 

2017–2020 30

Contents
Page ii GAO-18-245 Commercial Real Estate Lending

Figure 8: Historical Charge-offs from 2002–2017 (1 year moving 

average) with Predictive Model Forecast and Confidence 

Intervals, 2017–2020 31

Abbreviations

Call Report Consolidated Reports of Condition and Income 

CAMELS capital adequacy, asset quality, management,

earnings, liquidity, and sensitivity to market risk

CLD construction and land development

CRE commercial real estate

FDIC Federal Deposit Insurance Corporation

Federal Reserve Board of Governors of the Federal Reserve System

GDP gross domestic product

MRA matters requiring attention

MRBA matters requiring board attention

MRIA matters requiring immediate attention

OCC Office of the Comptroller of the Currency

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. The published product may be reproduced and distributed in its entirety 

without further permission from GAO. However, because this work may contain 

copyrighted images or other material, permission from the copyright holder may be 

necessary if you wish to reproduce this material separately.
Page 1 GAO-18-245 Commercial Real Estate Lending

441 G St. N.W.

Washington, DC 20548

March 15, 2018

The Honorable Elizabeth Warren

Ranking Member

Subcommittee on Financial Institutions and Consumer Protection

Committee on Banking, Housing, and Urban Affairs

United States Senate

Dear Senator Warren,

Concentrations in commercial real estate (CRE) loans at U.S. banks have 

been steadily increasing, raising safety and soundness concerns because 

of the potential for such concentrations to make the banks more 

susceptible to failure.1 As an asset class, CRE is prone to volatility and 

cyclical behavior, as illustrated by the sharp downturn in the CRE market 

generally following the 2007–2009 financial crisis. A bank’s CRE 

concentration can be measured by its ratio of CRE loans to its total 

capital.2 Since the early 2000s, community banks have trended toward 

providing CRE loans more than other kinds of loans.3 Following this trend, 

the Federal Deposit Insurance Corporation (FDIC), the Board of 

Governors of the Federal Reserve System (Federal Reserve), and Office 

of the Comptroller of the Currency (OCC) jointly issued guidance in 2006 

(hereafter referred to as the 2006 CRE guidance) that described their 

expectations for sound risk management practices for banks with 

 1

A CRE loan generally is used to acquire, develop, construct, improve, or refinance real 

property and where the primary source of repayment is the sale of the real property or the 

revenues from third-party rent or lease payments. CRE loans do not include ordinary 

business loans and lines of credit in which real estate is taken as collateral. For 

information on the role of CRE lending in bank failures, see Federal Deposit Insurance 

Corporation, Office of the Inspector General, Report to the Congress: Comprehensive

Study on the Impact of Failure of Insured Depository Institutions, Report No. EVAL-13-002 

(Arlington, Va.: January 2013), and Keith Friend, Harry Glenos, and Joseph B. Nichols, An 

Analysis of the Impact of the Commercial Real Estate Concentration Guidance

(Washington, D.C.: April 2013).

2

Capital generally is defined as a bank’s long-term source of funding, contributed largely 

by the bank’s equity stockholders and its own returns in the form of retained earnings. 

One important function of capital is to absorb losses.

3

Although no commonly accepted definition of a community bank exists, the term often is 

associated with smaller banks (e.g., under $1 billion in total assets) that provide 

relationship banking services to the local community and have management and board 

members who reside in the local community.

Letter
Page 2 GAO-18-245 Commercial Real Estate Lending

concentrations in CRE loans.4 In December 2015, the federal banking 

regulators jointly issued a public statement to remind banks of the 2006 

CRE guidance.5 According to the statement, the regulators observed that 

(1) many CRE asset and lending markets were experiencing substantial 

growth; and (2) certain risk management practices at some banks were 

causing concern, including a greater number of underwriting policy 

exceptions and insufficient monitoring of market conditions to assess the 

risks associated with these concentrations.

In our prior work, federal banking regulators told us that they have taken 

steps intended to improve their ability to identify and respond to emerging 

risks based on lessons learned from past banking crises.6 Our review of 

failed banks also found that regulators frequently identified weak 

management practices at banks involved in higher-risk activities early on 

in each crisis and before the banks began experiencing declines in 

capital. However, regulators were not always effective in directing bank 

management to address underlying problems before bank capital began 

to decline, and it was often too late to avoid failure. We have incorporated 

these and other regulatory lessons learned into a framework for 

monitoring federal banking regulators’ efforts to identify and respond to 

emerging risks to the banking system.7 Through such monitoring, we 

identified CRE for a targeted assessment of the federal banking 

regulators’ supervisory efforts.

We prepared this report under the authority of the Comptroller General to 

assist Congress with its oversight responsibilities. Given the federal 

banking regulators’ joint 2015 statement on CRE lending and our ongoing 

monitoring of their efforts to identify and respond to emerging threats to 

the banking system, this report examines

 4

Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, 

71 Fed. Reg. 74580 (Dec. 12, 2006). 

5

Board of Governors of the Federal Reserve System, Federal Deposit Insurance 

Corporation, and Office of the Comptroller of the Currency, Statement on Prudent Risk 

Management for Commercial Real Estate Lending (Washington, D.C.: December 2015). 

The statement also included a list of interagency regulations and guidance related to CRE

lending in addition to the 2006 CRE guidance, such as 12 CFR 364, appendix A.

6

See GAO, Bank Regulation: Lessons Learned and a Framework for Monitoring Emerging 

Risks and Regulatory Response, GAO-15-365 (Washington, D.C.: June 25, 2015). 

7

See GAO-15-365. 
Page 3 GAO-18-245 Commercial Real Estate Lending

• trends in the CRE lending markets, including changes in the level of 

credit and concentration risk in the markets, and

• actions taken by federal banking regulators through their 

examinations to help ensure that banks with CRE concentrations are 

effectively managing the related risks.

To address our objective on trends in the CRE lending markets, we 

reviewed academic literature and prior GAO work, analyzed FDIC, 

Federal Reserve, and other data on CRE markets and lending, and 

interviewed officials from federal banking agencies and CRE data 

providers. We evaluated trends in these data and used a subset of these 

data to estimate several predictive models of aggregate losses on bank 

CRE loans. For more information on our predictive models, see appendix 

II.

To address our objective on actions taken by federal banking regulators, 

we analyzed Consolidated Reports of Condition and Income (Call Report) 

data from SNL Financial for the period from 2011 through 2016 to 

calculate banks’ construction and land development (CLD) and CRE 

concentrations and identify banks whose concentrations exceeded, in full 

or in part, the 2006 CRE guidance during part or all of the period.8 Using 

such analysis, we selected a nongeneralizable sample of 40 banks that 

underwent full-scope examinations from 2013 through 2016 based on 

their CLD and total CRE concentrations, total assets, primary regulator, 

and geographic location. More specifically, we selected 20 FDICsupervised banks, 10 Federal Reserve-supervised banks, and 10 OCCsupervised banks. We requested from FDIC the reports of examination 

and related workpapers that covered its full-scope examinations of the 20 

banks conducted in 2013 or 2014 (20 examinations). We requested from 

the Federal Reserve and OCC the reports of examination and related 

workpapers that covered their two consecutive full-scope examinations of 

the 20 banks conducted from 2013 through 2016 (40 examinations).9

Although we requested a total of 60 bank examinations, we reviewed 54 

 8

SNL Financial recently became S&P Global Market Intelligence, a division of S&P Global. 

S&P Global Market Intelligence is a provider of financial data, news, and analytics. 

9

Although we requested two consecutive full-scope examinations from the Federal 

Reserve and OCC for our sampled banks, we did not take the same approach with FDIC. 

Officials from FDIC’s Office of Inspector General told us that they were conducting a 

similar review of CRE lending and planned to review a sample of FDIC’s examinations 

conducted in 2015 or later. To avoid duplicating this work, we limited our sample of FDIC 

bank examinations to those conducted in 2013 or 2014.
Page 4 GAO-18-245 Commercial Real Estate Lending

because 6 were not applicable to our review.10 We also interviewed 

officials from FDIC, Federal Reserve, and OCC regarding the CRE 

regulatory guidance and oversight by the federal banking regulators.

For the data that we used in our analyses under both of our objectives, 

we assessed the reliability of the data by, among other things,

interviewing knowledgeable officials, reviewing relevant documentation, 

and corroborating trends across multiple data sources. We determined 

the data were sufficiently reliable for our reporting objectives. For more 

information on our scope and methodologies, see appendix I.

We conducted this performance audit from January 2017 to March 2018 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

The purpose of federal banking supervision is to help ensure that banks 

throughout the financial system are operating in a safe and sound manner 

and are complying with banking laws and regulations in the provision of 

financial services. Banks in the United States are supervised by one of 

the following three federal regulators:

• FDIC supervises all FDIC-insured state-chartered banks that are not 

members of the Federal Reserve System and insured state savings 

associations and insured state chartered branches of foreign banks.

 10We did not review six examinations of banks supervised by the Federal Reserve. For 

five of the banks, the Federal Reserve did not conduct a full-scope examination of the 

banks during one of the two examination cycles in our review. Under the alternate-year 

examination program, banks that qualify are examined in alternate examination cycles by 

the Reserve Bank and the state banking agency. Another bank that we selected applied to 

become a member of the Federal Reserve System in 2016. Thus, the Federal Reserve 

had not conducted a full-scope examination of the bank during the time frame of our 

review, but did conduct a limited-scope, pre-membership examination targeting the bank’s 

CRE lending in 2016. We included this examination in our review.

Background

Federal Banking 

Supervision
Page 5 GAO-18-245 Commercial Real Estate Lending

• The Federal Reserve supervises commercial banks that are statechartered and members of the Federal Reserve System.

• OCC supervises federally chartered national banks and savings 

associations (also known as federal thrifts).

FDIC, the Federal Reserve, and OCC are required to conduct a fullscope, on-site examination of each of their supervised banks at least 

once during each 12-month period. The regulators may extend the 

examination interval to 18 months, generally for banks and thrifts that 

have less than $1 billion in total assets and that meet certain conditions, 

such as satisfactory ratings, are well capitalized, and are not being 

subject to a formal enforcement action.11 As part of a full-scope 

examination, examiners review a bank’s risk exposure within a number of 

components using the Uniform Financial Institutions Rating System, 

which also is referred to as the CAMELS rating system (capital adequacy, 

asset quality, management, earnings, liquidity, and sensitivity to market 

risk).12 Evaluations of CAMELS components consider a bank’s size and 

sophistication, the nature and complexity of its activities, and its risk 

profile.

The end result of a full-scope, on-site examination is a report of 

examination, which includes the CAMELS ratings and other findings and 

is provided to the bank’s management and board of directors. A report of 

examination may include deficiencies or other issues that examiners 

found and that a bank is expected to address within specific time frames. 

Such issues generally are called supervisory recommendations by FDIC, 

supervisory findings by the Federal Reserve, and supervisory concerns 

by OCC. For purposes of this report, we collectively refer to such issues 

as supervisory concerns. Supervisory concerns may be designed to 

correct practices that deviate from sound risk management principles or 

noncompliance with laws and regulations. Supervisory concerns that 

involve more significant issues are brought to the attention of a bank’s 

board of directors and senior management in the report of examination as 

 1112 U.S.C. § 1820(d)(4); Expanded Examination Cycle for Certain Small Insured 

Depository Institutions and U.S. Branches and Agencies of Foreign Banks, 81 Fed. Reg. 

90949 (Dec. 16, 2016).

12In an examination, a bank is rated for each of the CAMELS components and given a 

composite rating, which generally bears a close relationship to the component ratings. 

However, the composite is not an average of the component ratings. The component 

rating and the composite ratings are scored on a scale of 1 (best) to 5 (worst). Regulatory 

actions typically correspond to the composite CAMELS ratings, with the actions generally 

increasing in severity as the ratings become worse.
Page 6 GAO-18-245 Commercial Real Estate Lending

matters requiring immediate attention (MRIA) or matters requiring 

attention (MRA) under the Federal Reserve’s policies, matters requiring 

board attention (MRBA) under FDIC’s policies, and MRAs under OCC’s 

policies.13 If a bank were to fail to address a supervisory concern, its 

regulator could subject the bank to enhanced supervision, downgrade of 

a component or composite rating, or other supervisory actions, such as 

informal or formal enforcement actions.14

Under their 2006 guidance, regulators define CRE loans to include 

construction loans, loans to finance CRE that are not secured by CRE, 

loans secured by multifamily property, and loans secured by nonfarm, 

nonresidential property in which the primary source of repayment derives 

from the rental income associated with the property or the proceeds of the 

sale, refinancing, or permanent financing of the property. CRE loans in 

which the primary source of repayment is not the property itself are called 

owner-occupied loans and can include loans to businesses for working 

capital purposes that use real estate as collateral. For example, a line of 

credit for a business’s operating expenses might be secured in part by 

commercial property, such as an office.

Construction and land development (CLD) loans generally are considered 

to be the riskiest class of CRE, due to their long development times and 

because they can include properties (such as housing developments or 

retail space in a shopping mall) that are built before having firm 

commitments from buyers or lessees.15 In addition, by the time the 

 13The Federal Reserve generally defines (1) an MRIA as a matter of significant 

importance and urgency that a bank must address immediately and (2) an MRA as a 

matter that is important and that a bank is expected to address over a reasonable period 

of time but not immediately. FDIC generally defines an MRBA as a matter involving an 

issue or risk of significant importance that typically requires more effort by a bank to 

address than those correctable in the normal course of business. OCC generally defines 

an MRA as a deficient practice or a lack of a practice that could adversely affect the 

bank’s condition.

14In general, informal or formal enforcement actions are taken after the completion of an 

on-site bank examination, when warranted. Informal enforcement actions are used when 

circumstances warrant a less severe form of action than a formal enforcement action. 

Informal enforcement actions are not enforceable, and their violation cannot serve as a 

basis for assessing a civil money penalty or initiating a removal and prohibition action. 

Informal actions are not published or publicly available. Formal enforcement actions are 

authorized by statute and may be enforceable through the assessment of civil money 

penalties or the federal court system.

15CLD loans are also known as acquisition, development, and construction loans. 

CRE Lending and 

Associated Risks
Page 7 GAO-18-245 Commercial Real Estate Lending

construction phase is completed, market demand may have fallen, putting 

downward pressure on sales prices or rents—making this type of loan 

more risky.

Based on concerns about the increase in CRE concentrations at 

community banks and the risks associated with such concentrations, 

FDIC, the Federal Reserve, and OCC jointly issued guidance in 

December 2006 on CRE concentrations and sound risk management 

practices.16 The guidance described the regulators’ expectations for 

sound risk management practices for banks with concentrations in CRE 

loans. Specifically, the guidance identified seven key elements, or internal 

control areas, that a bank’s risk management practices should address to 

identify, monitor, and control its CRE concentration risk (see fig. 1).

Figure 1: Bank Internal Control Areas for Managing Commercial Real Estate Concentration Risk Based on 2006 Guidance

The 2006 CRE guidance also sets forth three criteria to identify banks 

with CRE loan concentrations that could be subject to greater supervisory 

scrutiny. According to the guidance, a bank that has experienced rapid 

growth in CRE lending, has notable exposure to a specific type of CRE, 

or is approaching or exceeds the following supervisory criteria may be 

 16Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, 

71 Fed. Reg. 74580 (Dec. 12, 2006).

Regulatory Guidance on 

CRE Concentrations and 

Risk Management 

Practices
Page 8 GAO-18-245 Commercial Real Estate Lending

identified for further supervisory analysis of the level and nature of its 

CRE concentration risk:

• CLD concentration threshold: CLD loans represent 100 percent or 

more of a bank’s total capital.17

• Total CRE concentration threshold: Total nonowner-occupied CRE 

loans (including CLD loans) represent 300 percent or more of a 

bank’s total capital and total CRE lending increased by 50 percent or 

more during the previous 36 months.

According to the guidance, the CLD and CRE thresholds do not constitute 

limits on a bank’s CRE lending activity but rather serve as high-level 

indicators to identify banks potentially exposed to CRE concentration risk.

In 2011, we reported on how the federal banking regulators had 

responded to the potential risks of growing CRE concentrations at 

community banks, including by jointly issuing the 2006 CRE concentration 

guidance.18 We recommended that the regulators should enhance or 

supplement the 2006 CRE guidance and take steps to better ensure that 

such guidance is consistently applied. The regulators have taken steps to 

address our recommendation.

Out of the approximately 5,900 banks that had a CRE loan portfolio as of 

the end of June 2017, a total of 504 banks exceeded either 100 percent in 

CLD loans as a percentage of total risk-based capital, or 300 percent in 

CRE loans as a percentage of total-risk based capital and had seen 50 

percent CRE portfolio growth during the previous 36 months. Of these 

504 banks, a total of 69 banks exceeded both the CLD criteria and the 

total CRE criteria (including the growth component).

In December 2015, federal banking regulators issued a joint statement to 

remind banks of the 2006 regulatory guidance on prudent risk 

management practices for CRE lending activity through economic cycles. 

The regulators noted, among other trends, that many banks’ CRE 

concentration levels had been rising. According to the statement, 

regulators would continue to pay special attention to potential risks 

associated with CRE lending during 2016. Specifically, the regulators 

 17In the 2006 guidance, total capital refers to the total risk-based capital as reported for 

commercial banks.

18See GAO, Bank Regulation: Enhanced Guidance on Commercial Real Estate Risks 

Needed, GAO-11-489 (Washington, D.C.: May 19, 2011).
Page 9 GAO-18-245 Commercial Real Estate Lending

stated that when conducting examinations that include a review of CRE 

lending activities, they would focus on banks’ implementation of the 

prudent principles in the 2006 CRE guidance and other applicable 

guidance relative to identifying, measuring, monitoring, and managing 

concentration risk in CRE lending activities.

According to officials from FDIC, the Federal Reserve, and OCC, their 

agencies use a variety of formal and informal processes to monitor the 

condition of banks and identify risks, including CRE concentration risk. 

For example, The Federal Reserve has a National Risk Council and FDIC 

and OCC have National Risk Committees that meet routinely to identify 

and evaluate risks facing banks and are supported by a number of other 

committees or other groups. FDIC officials told us that analysis done by 

FDIC’s Regional Risk Committees identified growth in CRE 

concentrations in 2015 and brought the issue to the National Risk 

Committee’s attention. OCC began actively monitoring CRE loan growth 

in the middle of 2014 and began focusing on CRE concentration risk 

management during bank examinations in 2015. OCC officials also stated 

that CRE concentration risk has been a key risk issue for the agency’s 

National Risk Committee since early 2016. Federal Reserve officials told 

us that the agency, including the Federal Reserve banks, began to 

monitor bank CRE concentrations more closely around mid-2013 after 

identifying an increase in CRE concentrations. According to FDIC, 

Federal Reserve, and OCC officials, they met together in early 2015 to 

discuss CRE lending growth and the rise in bank CRE loan 

concentrations and held subsequent meetings throughout the year, in part 

to discuss policy options for helping to ensure that banks were 

appropriately managing their CRE concentration risks. One of the 

outcomes of such interagency coordination was the December 2015 joint

statement on CRE concentrations.
Page 10 GAO-18-245 Commercial Real Estate Lending

Although the CRE sector has recovered since the 2007–2009 financial 

crisis, our trend and econometric analyses generally indicate that credit 

and other risks related to bank CRE lending have increased over the past 

several years.19

Based on indicators of CRE market conditions and loan performance, the 

CRE sector has recovered from the 2007–2009 financial crisis. For 

example, spending on CRE construction projects—a source of demand 

for bank financing—has rebounded. Vacancy rates for apartments, office 

buildings, and other CRE properties have declined. Similarly, as shown in 

figure 2, delinquency and charge-off rates on bank CRE loans have fallen 

from their post-crisis peaks and are at or below their lowest levels since 

2002.20 Although these rates provide information on the current 

performance of bank CRE loans, they provide little or no information 

about potential future risks faced by banks. For example, high-risk loans 

made to less creditworthy borrowers could perform well when property 

markets and the economy are doing well but may perform poorly when 

property markets or the economy begin to slow.

 19We discuss several types of risk in bank CRE lending, including market risk (e.g., the 

risk that commercial properties that serve as collateral for CRE loans could fall in value), 

credit risk (the risk that borrowers will fail to pay off their CRE loans), and concentration 

risk (e.g., an increase in the proportion of a bank’s lending that is exposed to a single 

sector or subsector—for example the CRE sector as a whole or CLD, a subset of the CRE 

sector).

20Charge-offs, which are the value of loans removed from the books and charged against 

loss reserves, are measured net of recoveries as a percentage of average loans and 

annualized. Delinquent loans are those past due 30 days or more and still accruing 

interest as well as those in nonaccrual status.

Credit and Other 

Risks Related to 

Bank CRE Lending 

Have Increased over 

the Past Several 

Years
Page 11 GAO-18-245 Commercial Real Estate Lending

Figure 2: Delinquency and Charge-off Rates on Bank Commercial Real Estate Loans from 2002 through Second Quarter of 

2017

Note: Charge-offs, which are the value of loans removed from the books and charged against loss 

reserves, are measured net of recoveries as a percentage of average loans and annualized. 

Delinquent loans are those past due 30 days or more and still accruing interest as well as those in 

nonaccrual status.

At the same time, our analyses of other market, underwriting, and lending 

data and forecasts from predictive econometric models we developed 

suggest that banks’ credit and concentration risks related to their CRE 

lending have increased. As shown in figure 3, according to a Federal 

Reserve survey, banks lowered their CRE loan underwriting standards—

terms and conditions under which banks extend loans—after the financial 

crisis, but more banks began to tighten their underwriting standards since 

late 2015.21 In general, tightening underwriting standards may indicate 

that loan officers are reevaluating the degree of risk in CRE markets 

served by banks. According to Federal Reserve data, a larger share of 

 21Underwriting standards include factors such as the capacity of the borrower or income 

from the underlying property to adequately service the debt; the market value of the 

underlying real estate collateral; the overall creditworthiness of the borrower; and the level 

of the borrower’s equity invested in the property.
Page 12 GAO-18-245 Commercial Real Estate Lending

banks has tightened underwriting standards on multifamily properties, 

such as apartments.

Figure 3: Change in Underwriting Standards by Banks for Commercial Real Estate Properties from First Quarter of 2002 

through Second Quarter of 2017

Note: We report results from the Federal Reserve’s Senior Loan Officer Opinion Survey, which 

summarizes changes in underwriting by the “net percentage” of banks tightening underwriting 

standards on various classes of loans—that is, the percentage of banks reporting that they have 

tightened standards minus the percentage of banks reporting that they have loosened standards. A 

positive number indicates that more banks are tightening than loosening standards. In the fourth 

quarter of 2013, the Federal Reserve updated the survey to disaggregate commercial real estate 

(CRE) into three balance sheet components: construction and land development, nonfarm 

nonresidential, and multifamily (right graph). Before the change, all CRE loans were reported in a 

single category. To report a consistent measure of aggregate CRE underwriting changes over a 

longer period of time (left graph), we constructed a weighted average of the more recent 

disaggregated survey results, weighting each CRE lending sector by the value of outstanding bank 

loans in that sector from FDIC’s Quarterly Banking Profile.

CRE property prices, particularly for multifamily properties, have 

increased rapidly in recent years, and CRE property valuations have 

similarly increased. For example, as shown in figure 4, capitalization rates 

(the ratio of income generated by a property to the property’s price) on 

CRE properties have trended downward since around 2010—indicating 

that borrowers (i.e., property owners) may be earning less of a return on 

their CRE properties. Capitalization rates can be indicative of expected 
Page 13 GAO-18-245 Commercial Real Estate Lending

future price changes—for example, low capitalization rates may reflect 

expectations of future price increase, but can also be driven by investor 

sentiment not associated with fundamental aspects of properties.22

Figure 4: Capitalization Rates on Commercial Real Estate Properties from January 2002 to September 2017

 22See, for example, “Cap Rates and Commercial Property Prices,” Federal Reserve Bank 

of San Francisco Economic Letters (Sept. 19, 2011) and Jim Clayton, David C. Ling, and 

Andy Naranjo, “Commercial Real Estate Valuation: Fundamentals vs. Investor Sentiment,”

Journal of Real Estate Finance and Economics (2009). Low capitalization rates may 

reflect market expectations of future increases in property income. However, market 

participants may be unwilling to pay for higher valuations—and will eventually bid prices 

down—should property income not increase as much or as soon as market participants 

initially expected. Consequently, falling property prices can reduce the value of collateral 

used to secure CRE loans and hence reduce the amount of protection banks have in the 

event of default. In addition, capitalization rates are expected to fluctuate with prevailing 

interest rates, and regulators told us that they also monitor the spread on capitalization 

rates over 10-year Treasury interest rates. This spread has fallen since 2013.
Page 14 GAO-18-245 Commercial Real Estate Lending

In addition, as shown in figure 5, the number of banks with concentrated 

portfolios in CLD or total CRE loans has been gradually increasing since 

around 2014. Greater concentrations in a particular lending sector (e.g., 

commercial real estate, residential real estate, or business lending) leave 

banks more vulnerable to a sectoral downturn, all else equal.

Figure 5: Number of Banks with Concentrations in Construction and Land Development and Total Commercial Real Estate 

Loans, First Quarter of 2007 through Second Quarter of 2017

Note: Similar to the 2006 commercial real estate (CRE) guidance, we define CRE concentrations as 

construction and land development loans representing 100 percent or more of a bank’s total capital or 

CRE loans representing 300 percent or more of a bank’s total capital. Because the figure focuses on 

CRE concentrations, we exclude the 50 percent growth rate criterion that is part of the guidance.

To further assess risk in bank CRE lending, we developed and estimated 

several predictive models of aggregate losses on bank CRE loans. The 

models incorporate measures of CRE property prices, bank lending, and 

underwriting standards. The models generally found that, historically, 

higher future losses are predicted when CRE lending and prices are 

simultaneously high relative to gross domestic product, and when banks 

are tightening underwriting standards. Based largely on the simultaneous 
Page 15 GAO-18-245 Commercial Real Estate Lending

increase in bank CRE lending and CRE prices observed over the last 

several years, these models suggest that credit risk has increased, 

though it remains lower than the level of risk associated with the 2007–

2009 financial crisis.23 As we noted earlier, high property valuations and 

substantial increases in lending can simultaneously weaken collateral 

protections and indicate lower borrower quality, both of which can raise 

the risk of losses should the economy or CRE sector weaken. (See app. II 

for additional information on our models.)

We found that regulators generally subjected banks with relatively high 

concentrations in CRE loans to greater supervisory scrutiny in 

comparison to banks with relatively lower concentrations in CRE loans in 

our review of 54 examinations for 40 banks conducted from 2013 through 

2016.24 In all of these examinations, the regulators specifically assessed 

whether each bank had adequate risk management practices and capital 

for managing its CRE concentration risk and generally found that the 

banks had adequate risk management practices and capital. In a few 

examinations, regulators differed in how they addressed supervisory 

concerns about a bank’s CRE-related risk management practices.

 23We developed these regression models based on, among other things, the existing early 

warning model literature which is designed to anticipate banking crises, e.g., Claudio Borio 

and Mathias Drehmann, “Assessing the risk of banking crises—revisited,” Bank for 

International Settlements Quarterly Review (March 2009). As these authors noted, 

models of this class are based on the idea that “imbalances manifest themselves in the 

coexistence of unusually rapid cumulative growth in private sector credit and asset prices.”

Our results were consistent with this concept and extend the aggregate early warning 

model literature to a sectoral model. We also performed diagnostic testing and assessed 

the forecasting ability of our models. The models’ in-sample and out-of-sample predictions 

conform to the broad pattern of CRE losses observed in recent decades but a limited data 

history also implies that our models and their predictions are subject to certain limitations. 

See appendix II for additional information on our models and associated limitations.

24We selected a judgmental, nonprobability sample of 40 banks which resulted in 54 

examinations for review. For more details on how we selected our sample of banks, see 

appendix I. 

Regulators Examined 

Risk Management 

Practices of Banks 

with CRE 

Concentrations
Page 16 GAO-18-245 Commercial Real Estate Lending

In our review of a nongeneralizable sample of 54 examinations conducted 

from 2013 through 2016, we found that FDIC, Federal Reserve, and OCC 

subjected banks with relatively high concentrations in CRE loans to 

greater supervisory scrutiny.25 In both their 2006 CRE guidance and 2015 

CRE statement, the regulators indicated that banks with relatively high 

CLD or total CRE concentrations should maintain risk management 

practices commensurate with the level and nature of their concentration 

risk. The 2006 CRE guidance recognized that the sophistication of a 

bank’s CRE risk management practices depends on, among other things, 

the level and nature of its CRE concentrations and associated risk. As 

noted earlier, the guidance notes that a bank’s risk management 

practices should address seven internal control areas: (1) board and 

management oversight; (2) portfolio management; (3) management 

information systems; (4) market analysis; (5) credit underwriting 

standards; (6) portfolio stress testing and sensitivity analysis; and (7) 

credit risk review function. Based on our analyses, we found that the 2006 

CRE guidance’s risk management framework is adequately designed to 

help ensure that banks effectively identify, measure, monitor, and control 

their CRE concentration risk. For example, the guidance is consistent with 

credit and concentration risk principles issued by international standardsetting bodies.26

Of the 54 reports of examination that we reviewed, 41 of them covered 

banks whose CLD or total CRE concentrations exceeded the CLD 

concentration threshold, total CRE concentration threshold, or both 

thresholds set forth in the 2006 guidance. In all of these examinations, we 

found that FDIC, Federal Reserve, and OCC examiners generally 

assessed whether each bank had implemented adequate risk 

 25According to the 2006 CRE guidance, the regulators will use three criteria to identify 

banks with CRE loan concentrations that could be subject to greater supervisory scrutiny. 

One of the supervisory criteria is that (1) CLD loans represent 100 percent or more of the 

bank’s total capital or (2) total CRE loans (generally defined as total nonowner-occupied

CRE and CLD loans) represent 300 percent or more of the bank’s total capital and the 

bank’s total CRE loans have increased by 50 percent or more during the previous 36 

months. Because several of the reports of examination we reviewed reported the banks’

total CRE concentrations but not their CRE growth rates, for our analysis we classified 

banks with total CRE concentration of 300 percent or more as banks that exceeded the 

CRE concentration criterion regardless of their CRE growth rate. Of the banks we 

classified as having exceeded the total CRE concentration criterion, some of them 

exceeded the 50 percent growth rates, but other banks may not have. 

26In addition, the regulators solicited public comments on a draft of the 2006 CRE 

guidance, collectively received more than 4,400 comment letters, and considered such 

comments in finalizing the guidance. 71 Fed. Reg. 74580, 74581 (Dec. 12, 2006).

Regulators Examined 

Whether Banks with 

Relatively High CRE 

Concentrations Had 

Adequate Practices and 

Capital to Manage Their 

CRE Concentration Risk
Page 17 GAO-18-245 Commercial Real Estate Lending

management practices to manage their concentration risk. As shown in 

figure 6, in 26 of the 41 examinations, FDIC, Federal Reserve, and OCC 

examiners did not find any weaknesses in the banks’ CRE risk 

management practices across the seven internal control areas, but did 

find weaknesses in the remaining 15 examinations.

Figure 6: Number of Sampled Examinations in Which Federal Banking Regulators 

Found a Commercial Real Estate-Related Risk Management Weakness in One or 

More of the Internal Control Areas

Note: The seven internal control areas are (1) board and management oversight; (2) portfolio 

management; (3) management information systems; (4) market analysis; (5) credit underwriting 

standards; (6) portfolio stress testing and sensitivity analysis; and (7) credit risk review function.

In 15 of the 41 examinations we reviewed, FDIC, Federal Reserve, and 

OCC examiners found the banks had CRE-related risk management 

weaknesses in at least one of the seven internal control areas. Examiners 

most frequently found risk management weakness in three internal 

control areas: board and management oversight (11 instances), 

management information systems (8 instances), and stress testing (7 

instances). To a slightly lesser extent, examiners found weaknesses in 

portfolio management, credit underwriting standards, and credit risk 

review function. Examiners communicated their supervisory concerns to 

these 15 banks in their reports of examinations.

• In 12 of the examinations, examiners included MRAs, MRBAs, or 

MRIAs in their reports of examination that directed the banks to 

correct their risk management weaknesses.

• In the other three examinations, examiners included 

recommendations or other notes in their reports of examination that 
Page 18 GAO-18-245 Commercial Real Estate Lending

generally directed the banks to correct their risk management 

weaknesses.

Consistent with the 2006 CRE guidance, we found that examiners 

generally did not use the CLD or total CRE concentration thresholds as 

limits on bank CRE lending.27 With two exceptions, examiners did not 

direct banks that exceeded the CLD or CRE threshold to reduce their 

concentrations but rather focused on ensuring that the banks’ risk 

management practices were commensurate with the nature and level of 

their concentration risk. In the two exceptions, examiners found the 

banks’ practices and capital inadequate for managing their CLD or CRE 

concentration risk and directed the banks to reduce their concentrations 

and improve their risk management practices.

We found that FDIC, Federal Reserve, and OCC examiners varied in the 

extent to which they documented—in the reports of examination and 

supporting workpapers—the scope of their review of banks’ CRE-related 

risk management practices and findings. For example, we were not 

always able to determine whether examiners found a bank’s practices 

adequate in one or more of the seven internal control areas based on our 

review of the report of examination and, if available, supporting 

workpapers. According to the regulators, reports of examinations are 

used primarily to document practices found to be inadequate and not 

practices found to be adequate. Moreover, the regulators told us that their 

examiners recently have been required to use a CRE examination 

module to document their assessment and findings of banks with 

concentrations exceeding the CLD or CRE threshold.28

In the 41 examinations we reviewed where banks exceed one of the 

concentration thresholds, FDIC, Federal Reserve, and OCC examiners 

assessed whether the banks generally had capital commensurate with 

 27As noted earlier, according to the 2006 CRE guidance, the supervisory criteria for CLD 

and total CRE concentrations do not constitute limits on a bank’s lending activity but rather 

serve as high-level indicators to identify banks potentially exposed to concentration risk. 

28According to OCC officials, the agency created an electronic workpaper in August 2017 

that its examiners use to document their review of the CRE-related risk management 

practices of banks exceeding the CLD or total CRE threshold. Similarly, FDIC instituted a 

CRE work-program on April 1, 2017, that requires its examiners to document their review 

of the risk management practices across the seven internal control areas for banks 

exceeding the CLD or total CRE threshold. While the Federal Reserve has had a CRE 

examination module that examiners used at their discretion, Federal Reserve officials told 

us that their examiners were directed to use the module when examining banks exceeding 

the CLD or total CRE threshold after the issuance of the joint 2015 CRE statement.

Capital and Concentration Risk
Page 19 GAO-18-245 Commercial Real Estate Lending

their CRE concentration risk. In 34 of the examinations, examiners 

determined that the banks’ capital levels were adequate for managing 

their CLD or total CRE concentration risk. In 7 of the examinations, 

examiners determined that the banks’ capital levels were inadequate. For 

six of the seven banks, examiners directed the banks in the reports of 

examination to reduce or manage their CRE concentrations in light of 

inadequate capital. In the case of one bank, examiners required the bank 

to comply with a previous formal enforcement action that addressed the 

need for the bank to adhere to its board-approved capital plan.

For banks with relatively high CLD or total CRE concentrations, we found 

that Federal Reserve and OCC examiners assessed the banks’ CRErelated risk management practices in subsequent examinations.29 In our 

review of 41 examinations of banks that exceeded the CLD or CRE 

threshold, 26 of them covered two examination cycles of 13 banks 

conducted from 2013 through 2016. We found that examiners assessed 

the banks’ practices for managing their concentration risk in both 

examinations.

• In 14 examinations (covering 7 banks), examiners found that the 

banks had adequate risk management practices in both examinations.

• In six examinations (covering three banks), examiners found aspects 

of the banks’ risk management practices to be inadequate in their 

2013 or 2014 examination and noted their supervisory concerns in the 

reports of examination. In the subsequent examinations, the 

examiners found that the banks had adequately addressed the 

previously identified risk management weaknesses.

• In six examinations (covering three banks), examiners found the 

banks’ practices for managing their CRE concentration risk to be 

adequate in the 2013 or 2014 examinations but inadequate in the 

subsequent examinations. The examiners issued the banks MRAs or 

MRIAs or took an informal enforcement action.

 29FDIC’s Office of Inspector General is conducting a similar review of CRE lending and 

planned to review a sample of FDIC’s examinations conducted in 2015 and later. To avoid 

duplicating such work, we limited the scope of our work to review FDIC examinations 

conducted in 2013 or 2014.

Review of CRE-Related 

Risk Management 

Practices in Subsequent 

Examination Cycles
Page 20 GAO-18-245 Commercial Real Estate Lending

For banks with concentrations below the CLD or total CRE threshold, we 

found that regulators generally did not examine the banks’ CRE-related 

risk management practices. Thirteen of the 54 examinations we reviewed 

covered banks that did not exceed the CLD or CRE thresholds. Although 

the banks did not exceed either threshold, OCC examiners assessed the 

banks’ CRE-related risk management practices in 3 of the 

examinations.30 In 1 examination, examiners determined that the bank’s 

CRE-related risk management practices were adequate. The other 2 

examinations covered subsequent cycle examinations of the same bank. 

In the first examination, examiners found that the bank had adequate 

practices for managing risk associated with its CRE loans but directed the 

bank through an MRA to incorporate stress testing of the loan portfolio 

into its monitoring. In the subsequent examination, the examiners found 

that the bank had addressed the MRA. In the other 10 examinations, 

FDIC, Federal Reserve, and OCC examiners did not mention in the report 

of examination the banks’ practices for managing the risk associated with 

their CRE loans.

FDIC, Federal Reserve, and OCC officials told us that examiners use 

their professional judgment in determining whether to review a bank’s 

CRE-related risk management practices if the bank’s concentration is 

below the CLD and CRE threshold. This approach is consistent with the 

overall risk-based supervisory process used by the regulators, which 

focuses examiner resources on assessing bank management’s ability to 

identify and control risks. For example, FDIC’s examination guidelines 

note that examiners should focus their resources on a bank’s highest risk 

areas when assessing risk management programs, financial conditions, 

and internal controls.31 According to the guidance, the exercise of 

examiner judgment to determine the scope and depth of review in each 

functional area is crucial to the success of the risk-focused supervisory 

process.

 30According to the 2006 CRE guidance, the CLD and CRE thresholds serve as a screen 

for identifying banks with potential CRE concentration risk but should not be viewed as a 

“safe harbor” if other risk indicators are present. The guidance also notes that banks 

experiencing recent, significant growth in CRE lending are to receive closer supervisory 

review than other banks that have demonstrated a successful track record of managing 

the risks in CRE concentrations.

31See, for example, Federal Deposit Insurance Corporation, RMS Manual of Examination 

Policies, Basic Examination Concepts and Guidelines (February 2016).

Regulators Generally Did 

Not Examine CRE-Related 

Risk Management 

Practices of Banks with 

Concentrations below the 

CLD or Total CRE 

Threshold
Page 21 GAO-18-245 Commercial Real Estate Lending

In a few examinations, we found differences across regulators in how 

they addressed supervisory concerns about banks’ CRE-related risk 

management practices because of differences in the regulators’ policies. 

In our nongeneralizable sample of 54 examinations, Federal Reserve, 

FDIC, and OCC examiners included CRE-related supervisory concerns, 

such as recommendations, MRAs, or MRBAs, in 22 of the reports of 

examinations.32 Although the regulators have policies for identifying and 

communicating supervisory concerns, their policies use different criteria. 

For example, OCC’s policies instruct examiners to use MRAs to describe 

practices that a bank must implement or correct to address a deficiency 

and not to use MRAs to require enhancements to bank practices that 

meet acceptable standards.33 However, the Federal Reserve’s and 

FDIC’s policies do not expressly include such criteria.34 Consistent with 

their policies, OCC examiners included MRAs in the reports of 

examination that we reviewed only when they found a bank’s CRE-related 

risk-management practices to be inadequate. In contrast, in 2 reports of 

examination, we found that FDIC examiners did not find the banks’ CRErelated risk management practices to be inadequate but included MRBAs 

to direct the banks to enhance or sustain certain CRE-related risk 

management practices. Similarly, in 1 report of examination, Federal 

Reserve examiners found that the bank’s risk management practices and 

capital were adequate for its CRE concentrations but included an MRA to 

 32Specifically, we found that examiners communicated their supervisory concerns as an 

MRA, MRIA, or MRBA in 16 of these examinations and as recommendations in the 

remaining 6 examinations. In general, recommendations are less stringent than MRAs, 

MRIAs, and MRBAs.

33According to OCC’s policies, MRAs describe practices that a bank must implement or 

correct, ideally before those deficient practices affect the bank’s condition. 

34According to FDIC’s policies, supervisory recommendations may be designed to correct, 

among other things, practices that deviate from sound governance, internal controls, or 

risk management principles. Supervisory recommendations also may be designed to 

encourage an institution to more fully take into account supervisory guidance in a manner 

that is commensurate with the institution’s nature of business, size, and complexity for 

safety and soundness or consumer protection purposes. According to FDIC’s policies, 

recommendations may be included in the report of examination and most 

recommendations are correctable in the normal course of business, but recommendations 

involving an issue or risk of significant importance that would typically require more effort 

to address than those correctable in the normal course of business, need to be brought to 

the attention of the board and senior management through comments in an MRBA. 

According to the Federal Reserve’s policies, MRAs constitute matters that are important 

and that the Federal Reserve expects a bank to address over a reasonable period of time, 

but the timing need not be immediate. 

Regulators Differed in How 

They Addressed a Few 

Supervisory Concerns 

about Banks’ CRE-Related 

Risk Management 

Practices
Page 22 GAO-18-245 Commercial Real Estate Lending

require the bank to enhance its capital plan to include concentration risk 

considerations.

In addition to their examinations, federal banking regulators have taken 

informal and formal enforcement actions against banks for not adequately 

managing their CRE concentration risk. In general, initial consideration 

and determination of whether informal or formal action is required usually 

results from examination findings. Unlike informal enforcement actions, 

formal enforcement actions are published or publicly available. From 

2013 through 2016, FDIC, the Federal Reserve, and OCC took formal 

enforcement actions against banks for not adequately managing risks 

related to their CRE concentrations, including those outlined in the jointly 

issued 2006 CRE guidance.

• FDIC took 22 formal enforcement actions against banks for matters 

related to their CRE concentrations during this period.

• The Federal Reserve took 2 formal enforcement actions against 

banks for matters related to their risk management of CRE lending.

• OCC took 11 formal enforcement actions against banks for matters 

related to their CRE concentrations during this same period.

The majority of these formal enforcement actions discussed the 2006 

CRE guidance and directed the banks to improve their practices for 

managing their CRE concentration risk. For example, in a number of 

formal enforcement actions, the regulators ordered the banks to revise 

their written concentration risk management programs for identifying, 

monitoring, and controlling risks associated with concentrations of credit, 

consistent with the 2006 CRE guidance.

We provided a draft of this report to FDIC, the Federal Reserve, and, 

OCC for review and comment. The agencies provided technical 

comments, which we incorporated as appropriate.

We are sending copies of this report to the appropriate congressional 

committees and FDIC, the Federal Reserve, and OCC. This report will 

also be available at no charge on our website at http://www.gao.gov.

Should you or your staff have questions concerning this report, please 

contact me at (202) 512-8678 or evansl@gao.gov. Contact points for our 

FDIC, Federal Reserve, 

and OCC Have Recently 

Taken Formal 

Enforcement Actions 

against Banks for Not 

Adequately Managing 

Their CRE Concentration 

Risk

Agency Comments
Page 23 GAO-18-245 Commercial Real Estate Lending

Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. Key contributors to this report are listed in 

appendix VII.

Lawrance L. Evans, Jr.

Managing Director, Financial Markets and Community Investment
Appendix I: Objectives, Scope, and 

Methodology

Page 24 GAO-18-245 Commercial Real Estate Lending

Our objectives in this report were to examine: (1) trends in the 

commercial real estate (CRE) lending markets, including changes in the 

level of credit and concentration risk in the markets, and (2) actions 

federal banking regulators took through their examinations to help ensure 

that banks with CRE concentrations are effectively managing the related 

risks.

To examine trends in the CRE lending markets, we reviewed academic 

literature and prior GAO work and interviewed officials from the federal 

banking regulators and private data providers. Specifically, we 

interviewed officials at the Board of Governors of the Federal Reserve 

System (Federal Reserve), the Federal Deposit Insurance Corporation 

(FDIC), and the Office of the Comptroller of the Currency (OCC) to help 

identify potential indicators of risk in CRE markets. To further inform our 

assessment of risk, we reviewed prior GAO work on the lessons learned 

from prior banking crises and the use of early warning models for 

monitoring the financial system.1 We also reviewed academic research on 

early warning models of banking and real estate-related crises.

To report trends and assess risk, we reviewed and analyzed a range of 

data that we considered to be reflective of various aspects of risk in CRE 

lending markets. Specifically, we reviewed and analyzed commercial 

property vacancy data from REIS (a private commercial real estate data 

provider); commercial property construction data from the U.S. Census 

Bureau; data on delinquencies and charge-offs on bank CRE loans from 

the Federal Reserve; data on commercial property prices and 

capitalization rates from Real Capital Analytics (a private commercial real 

estate data provider); FDIC data on bank CRE lending; and Federal 

Reserve data on underwriting standards. We evaluated trends in these 

data and used a subset of these data to estimate several predictive 

models of aggregate losses on bank CRE loans. (See app. II for more 

information on our predictive models.)

To examine actions taken by federal regulators to help ensure that banks 

with high CRE concentrations are effectively managing the related risks, 

we reviewed and analyzed their relevant guidance and regulations on 

 1

See GAO, Bank Regulation: Lessons Learned and a Framework for Monitoring Emerging 

Risks and Regulatory Response, GAO-15-365 (Washington, D.C.: June 25, 2015) and 

Financial Stability: New Council and Research Office Should Strengthen the 

Accountability and Transparency of Their Decisions, GAO-12-886 (Washington, D.C.: 

Sept. 11, 2012).

Appendix I: Objectives, Scope, and 

Methodology
Appendix I: Objectives, Scope, and 

Methodology

Page 25 GAO-18-245 Commercial Real Estate Lending

bank CRE lending, examination policies and procedures (e.g., 

examination manuals and modules), studies and other publications on 

risks in the banking industry, and formal enforcement actions taken from 

2013 through 2016 for CRE-related matters. In addition, we analyzed 

Consolidated Reports of Condition and Income data from SNL Financial 

for the period from 2011 through 2016 to calculate banks’ construction 

and land development (CLD) and CRE concentrations during the period.2

Specifically, we used the concentration formulas in the 2006 CRE 

concentration guidance (jointly issued by the federal banking regulators) 

to calculate banks’ CLD and CRE concentrations and identify banks 

whose CRE concentrations exceeded, in full or in part, the guidance’s 

CRE concentration thresholds during part or all of the time frame. 3 Based 

on whether the banks’ CRE concentrations exceeded the thresholds and 

other criteria discussed below, we selected a nongeneralizable sample of 

40 banks overseen by FDIC, the Federal Reserve, or OCC. For the banks 

in our sample, we requested from the regulators copies of the reports of 

examination and, if available, related workpapers prepared by the 

regulators based on their full-scope examinations of the banks done from 

2013 through 2014, and from 2015 through 2016.

In addition to using banks’ CRE concentrations as a basis to select 

examinations, we judgmentally selected a nonprobability sample of banks 

based on the following criteria:

• Total asset size: We considered the size of the banks based on their 

total assets and selected banks from each of the following three 

ranges: (1) banks with $1 billion or more in total assets, (2) banks with 

$100 million or more but less than $1 billion in total assets, and (3) 

banks with less than $100 million in total assets.

 2

SNL Financial recently became S&P Global Market Intelligence, a division of S&P Global. 

S&P Global Market Intelligence is a provider of financial data, news, and analytics. 

3

Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, 

71 Fed. Reg. 74580 (Dec. 12, 2006). 
Appendix I: Objectives, Scope, and 

Methodology

Page 26 GAO-18-245 Commercial Real Estate Lending

• Primary regulator: We considered the primarily regulator of the 

banks and selected a sample of 40 banks that resulted in a total of 20 

examinations to review from each regulator.4

• Geographic distribution: We selected banks to ensure that at least 

one bank was from each of the four regions of the U.S. Census and 

each of the nine divisions within those regions.

Based on the 40 banks we selected, we reviewed and analyzed 54 

reports of examination and, if available, the related workpapers. We 

analyzed the examinations using criteria or other requirements specified 

in the 2006 CRE guidance jointly issued by the regulators and their 

examination policies and procedures. We did not review six examinations 

of banks supervised by the Federal Reserve.5 We also interviewed 

officials from FDIC, Federal Reserve, and OCC, and from a national 

banking association about bank CRE lending and applicable CRE 

guidance and requirements.

For the data we analyzed under both of our objectives, we took a number 

of steps to assess the reliability of the data, including interviewing data 

providers; corroborating trends across multiple data sources; reviewing 

related documentation; inspecting data for missing values, outliers, or 

other errors; and reviewing relevant, prior GAO work. We determined that 

these data were sufficiently reliable for our reporting objectives.

 4

We selected a total of 20 banks to review from FDIC, 10 from the Federal Reserve, and 

10 from OCC. We selected 20 banks from FDIC because, during the course of work, 

officials from FDIC’s Office of Inspector General told us that they were conducting a 

similar review of CRE lending and planned to review a sample of FDIC’s examinations 

conducted in 2015 or later. As such, we requested examination reports and workpapers 

for examinations issued during only one of the cycles in our sample—the 2013–2014 

cycle—to arrive at a total of 20 examinations to review from FDIC. We selected 10 banks 

each from the Federal Reserve and OCC for examinations conducted in both cycles—

2013–2014 and 2015–2016—to arrive at a total of 20 examinations to review from each of 

these two regulators. 

5

For five of the banks, the Federal Reserve did not conduct a full-scope examination of 

the banks during one of the two examination cycles in our review. Under the alternateyear examination program, banks that qualify are examined in alternate examination 

cycles by the Reserve Bank and the state. Thus, a particular bank would be examined by 

the Reserve Bank in one examination cycle and the state in the next. If a state solely 

conducted the bank examination, we did not request and review the examination. Another 

bank that we selected applied to become a member of the Federal Reserve System in 

2016. Thus, the Federal Reserve did not conduct a full-scope examination of the bank 

during the time frame of our review, but did conduct a limited-scope, pre-membership 

examination targeting the bank’s CRE lending in 2016. We included this examination in 

our review..
Appendix I: Objectives, Scope, and 

Methodology

Page 27 GAO-18-245 Commercial Real Estate Lending

We conducted this performance audit from January 2017 to March 2018 

in accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.
Appendix II: GAO Predictive Models of 

Aggregate Losses on Bank Commercial Real 

Estate Loans

Page 28 GAO-18-245 Commercial Real Estate Lending

We developed and estimated several models of aggregate losses on 

bank commercial real estate (CRE) loans. These models attempt to 

predict future aggregate charge-offs using contemporary indicators of 

potential risks.1 We incorporated indicators of risk based on the crosscountry research literature on early warning models of banking risk and 

prior GAO work on identifying early warning models as tools that could 

assist financial regulators in assessing risk.2 One study summarized the 

overall intuition for models of this class in the following way: “imbalances 

manifest themselves in the coexistence of unusually rapid cumulative 

growth in private sector credit and asset prices.”3 Our results were 

consistent with this concept and extend the aggregate early warning 

model literature to a sectoral model. As such, our models incorporate 

measures of CRE property prices, bank lending volumes, and bank loan 

underwriting standards.

The models predict charge-offs 2–3 years into the future (the dependent 

variable is the average charge-off rate for 8 through 11 quarters into the 

future), using commercial bank charge-off rates from the Board of 

Governors of the Federal Reserve System (Federal Reserve), first quarter 

1991 to second quarter 2017. (See below for an illustrative regression 

equation for one of these models.)

We began with two model variations, one based on the levels of key 

variables and the other based on their growth rates, using the following 

independent variables, respectively:

• “Level” model: Level of CRE prices to gross domestic product (GDP), 

level of bank CRE lending to GDP, the interaction of the level of CRE 

prices and lending, and the net percentage of banks tightening 

underwriting standards on CRE loans.

 1

Charge-offs, which are the value of loans removed from the books and charged against 

loss reserves, are measured net of recoveries as a percentage of average loans and 

annualized.

2

See Claudio Borio and Mathias Drehmann, “Assessing the risk of banking crises—

revisited,” Bank for International Settlements Quarterly Review (March 2009); Stijn Ferrari, 

Mara Pirovano, and Wanda Cornacchia, Identifying early warning indicators for real 

estate-related banking crises, European Systemic Risk Board Occasional Paper Series 

no. 8 (August 2015); and GAO-12-886. 

3

Claudio Borio and Mathias Drehmann, “Assessing the risk of banking crises—revisited,”

Bank for International Settlements Quarterly Review (March 2009).

Appendix II: GAO Predictive Models of 

Aggregate Losses on Bank Commercial Real 

Estate Loans
Appendix II: GAO Predictive Models of 

Aggregate Losses on Bank Commercial Real 

Estate Loans

Page 29 GAO-18-245 Commercial Real Estate Lending

• “Growth” model: Growth rate of CRE prices over the last year, growth 

rate of bank CRE lending over the last year, interaction of price and 

lending growth, and the net percentage of banks tightening 

underwriting standards on CRE loans.

All variables are based on quarterly U.S. data, including CRE price 

indices from Real Capital Analytics and Standard & Poor’s, bank balance 

sheet data from the Federal Deposit Insurance Corporation, underwriting 

data from the Federal Reserve’s Senior Loan Officer Opinion Survey, and 

gross domestic product and associated deflators from the Bureau of 

Economic Analysis. We estimated both models and assessed in-sample 

fit while reserving the last year of data for out-of-sample testing. The 

model based on levels had far superior in-sample fit, and we iterated from 

that model in additional specifications. Out-of-sample fit for the model 

based on levels was somewhat weaker than in-sample fit. The regression 

equation for this model is below:

CCCCCC cchaaaaaaaa − oooooo rr tt+2 tttt 3

= ββ0 + ββ1 × CCCCCC bb bbbb ll ll/GGGGGGtt + ββ2

× CCCCCC pp pp /GGGGGGtt+ ββ3

× NN pp oooo bb bbbb h CCCCCC uu uu uu tt

+ ββ4 × (CCCCCC bb bbbb ll ll/GGGGGGtt × CCCCCC pp pp /GGGGGGtt) + εεtt

By inspection, the model based on levels also captured key aspects of 

the evolution of aggregate losses on bank CRE loans in recent 

decades—for example, low charge-offs prior to the crisis, the rapid 

increase during crisis, and very low charge-offs in recent years. In this 

model higher losses are predicted by tightening underwriting standards, 

and the interaction of (i.e., simultaneous increase in) the level of CRE 

prices and the level of CRE lending. The bulk of the explanatory power of 

the model appears to come from the interaction of the level of CRE prices 

and the level of CRE lending—consistent with Borio and Drehmann’s 

view that the coexistence of rapidly increasing credit and prices is 

associated with greater risk.4 These results are also consistent with a 

more general theory, for example, that periods of economic stability 

induce greater risk-taking over time, bidding up asset prices and 

 4

Claudio Borio and Mathias Drehmann, “Assessing the risk of banking crises—revisited,”

Bank for International Settlements Quarterly Review (March 2009).
Appendix II: GAO Predictive Models of 

Aggregate Losses on Bank Commercial Real 

Estate Loans

Page 30 GAO-18-245 Commercial Real Estate Lending

loosening underwriting standards until ultimately increased valuations 

become unsustainable, prices fall, and borrowers begin to default.5

We estimated a number of additional models for robustness, to determine 

if goodness-of-fit and forecasts could be improved markedly, and to 

assess the degree of forecast uncertainty. For example we estimated a 

model with a censored dependent variable and used information criteria 

to select models that combined elements from our initially separate 

models based on growth rates and levels as well as a model that includes 

current charge-offs. In figure 7, we report the general trend in expected 

future charge-offs as well as convey forecast uncertainty based on 

differences in the forecasts of three of these models.

Figure 7: Historical Charge-offs from 2002–2017 (1 year moving average) with Predictive Model Forecast Comparison, 2017–

2020

 5

See, e.g., Hyman Minsky, The financial instability hypothesis, Levy Economics Institute 

Working Paper no. 74 (May 1992) and Karl Case and Robert Shiller, “Is there a bubble in 

the housing market?” Brookings Papers on Economic Activity, vol. 2003, no. 2 (2003).
Appendix II: GAO Predictive Models of 

Aggregate Losses on Bank Commercial Real 

Estate Loans

Page 31 GAO-18-245 Commercial Real Estate Lending

In figure 8, we convey forecast uncertainty based on the 75 percent 

confidence interval for a combined model that we selected based on 

information criteria.

Figure 8: Historical Charge-offs from 2002–2017 (1 year moving average) with Predictive Model Forecast and Confidence 

Intervals, 2017–2020

Implicit in this exercise is the assumption that the data-generating 

process is reasonably stable—as a result, structural change associated 

with new financial products, new risk management tools, and new legal 

and regulatory frameworks could reduce the stability of the datagenerating process. We interpret our results and forecasts in light of 

these potential limitations. Specifically, we do not interpret model results 

as concrete, precise predictions of aggregate commercial real estate 

losses but rather as an additional, general indication of the degree of risk 

in bank CRE lending.

We mitigate risks associated with estimating this type of model with 

appropriate diagnostics, out-of-sample testing, and by developing the 

model in the context of the well-established early warning literature. That 
Appendix II: GAO Predictive Models of 

Aggregate Losses on Bank Commercial Real 

Estate Loans

Page 32 GAO-18-245 Commercial Real Estate Lending

said, some inevitable limitations remain, including the potential omission 

of important risk factors and other approximations associated with our 

specification (e.g., our choice of a linear functional form). In addition, 

diagnostics for detecting nonstationary time series are imperfect, 

especially with small sample sizes, which may inflate our measures of 

statistical significance and traditional goodness-of-fit measures like rsquared. These biases may be present, however, in models that still 

generate useful predictions. In this “small data” context there is also risk 

of fitting (or over-fitting) the model to predict a particular credit event—

though, again, this risk is mitigated somewhat in the context of the broad 

cross-country early warning literature and the use of out-of-sample 

testing.
Appendix III: GAO Contact and Staff 

Acknowledgments

Page 33 GAO-18-245 Commercial Real Estate Lending

Lawrance Evans, 202-512-8678, or evansl@gao.gov

In addition to the contact named above, Richard Tsuhara (Assistant 

Director), Tarek Mahmassani (Analyst in Charge), Abigail Brown, Tarik 

Carter, M’Baye Diagne, Michael Hoffman, Risto Laboski, Marc Molino, 

Jessica Sandler, Jennifer Schwartz, and Andrew Stavisky made 

significant contributions to this report.

Appendix III: GAO Contact and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(101521)
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