Credit Risk Analysis of Commercial Real Estate Lending
When assessing the creditworthiness of the borrowers in cases of CRE lending, in addition to the general criteria for the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should apply the specific criteria set out in this section. When assessing the creditworthiness of the borrowers in cases of lending for commercial real estate to be used by the borrower that owns the property for conducting business, institutions should apply the criteria set out in Section 5.2.5 and Section 5.2.6 only.
Institutions should assess and verify the borrower’s experience in relation to the type, size and geographical location of the CRE. When the borrower is a special purpose vehicle sponsored by another entity, institutions should assess the sponsoring entity’s experience in relation to the type, size and geographical location of the CRE.
Institutions should carry out an assessment of the income-producing capacity of the property and an assessment of the prospect of refinancing. These assessments should account for the committed term of the CRE loan under the loan application in question.
In the assessment of the borrower’s repayment capacity, institutions should assess, where relevant:
- the sustainability of the cash flow;
- the quality of the tenants, the impact of changes to current rental income on the amortisation schedule, lease terms, maturities and conditions, and payment history of the tenant if already in place;
- reletting prospects, the cash flow required to service the loan in accordance with the loan agreement if there are needs for reletting, if applicable the performance of the asset in an economic downturn, and fluctuations in rental yields over time, to assess the presence of overly compressed yields;
- necessary capital expenditure on the property throughout the term of the loan.
In the assessment of the prospects of reletting any property, institutions should account for tenants’ demand for that property, having regard to the supply of comparable properties, the conditions and specifications of the property, the location of the property and the proximity to relevant infrastructure serving the property.
When interest-only loans are advanced for CRE, institutions should assess property cash flow to support a level of amortisation equivalent to the projected economic life cycle of the property, to clear the principal amount and interest of the loan in the event of an increase in the loan to value (LTV) for the property, or to a regular LTV level in the relevant market. Institutions should also consider such analysis when borrowers have additional credit enhancements, e.g. disposal assets that are legally enforceable in a reasonable time period.
For the purposes of the sensitivity analysis under adverse market and idiosyncratic events, institutions should, in addition to the events specified in Section 5.2.5 and Section 5.2.6, take into account the following, as applicable:
- reletting, including a change in the rental prices, lease length in relation to loan term service charges, an increase in vacancy rates, maintenance and refurbishment costs, rent-free periods and letting inducement;
- risks and delays associated with refinancing;
- capital expenditure risk;
- other relevant criteria.
- EBA, Guidelines on loan origination and monitoring EBA/GL/2020/06