What Goes Up Must Come Down: Stay Ahead of the Curve

by: Smith and Howard

June 27, 2018

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With strong real estate markets in many parts of the country, lenders might feel they’re sitting pretty. But before you allow good times to lull you into complacency, remember that markets are cyclical. Are you prepared for the next economic slump? Weathering an economic downturn requires a plan. Yet waiting until the economy slows to develop one can lead to hasty, uninformed decisions.

Instead of making plans under pressure, take time now to envision how your bank would respond to a softening in lending demand. This includes how you’d decide which loans you might call and how you’d deepen relationships with existing customers that you want to retain.

Developing criteria for evaluating loans

Before economic activity slows, develop quantitative and qualitative criteria to use in analyzing your loan portfolio — and identify loans to call when the economy softens. Rank your loans according to the likelihood of calling them and model the impact of doing so on your book of business. Assess the potential implications of calling each loan, in terms of the drop in interest income and the potential loss of demand deposit accounts.

When identifying which loans to call, make sure that your loan files contain your customers’ latest financial records. If a file lacks an up-to-date financial statement, consider contacting the borrower to request an update — or schedule a visit to the company’s office to obtain a copy. While there, you’ll have the opportunity to ask questions and assess the current health of the business in person.

Tracking customers’ banking activity

When the economy slows, changes in a borrower’s financial performance often evolve slowly. But if a borrower initiates a significant one-time transaction, such as withdrawing funds to use their remaining line of credit or transferring a large cash balance to an external account, this could be a red flag.

While the economy is healthy, make sure the processes are in place to automatically notify you of insufficient funds so that you receive an early warning of a borrower’s inability to meet financial obligations. Also evaluate the reporting you have in place surrounding borrower payment and account activity. In particular, be aware of the frequency and depth of analysis the reporting provides.

Reviewing the exit process

Exiting a loan requires a unique set of skills. Your bank’s special asset department exists to help protect the bank’s interests while working toward ending the customer relationship.

Now’s the time to review the process that your bank follows to transfer a loan to the special assets department, including the role you’re expected to play once it’s assigned. This will help you know what to expect in the event that a borrower defaults. It’s important to note that, after the special assets division assumes control of a lending relationship, that loan rarely returns to normal credit status.

Identifying borrowers that should receive increases

When the economy contracts, otherwise healthy borrowers may find themselves in need of additional funds. Having determined which lending relationships to close, you’ll need to identify borrowers that would merit additional funding, should the need arise.

This process is similar to the process of assessing loans to call. You’ll need accurate financial records and statements on hand to make a fully informed decision about any borrower’s future funding needs. Because your bank might increase the borrower’s loan facility, use this time to deepen your relationship. You may want to meet them face-to-face to request their latest financials and reacquaint yourself with their business, confirming the preliminary decision to increase their debt facility.

Plan for the worst

A decline in the number of loan applications is inevitable when there’s a slowdown. But an effective plan can help stave off loan problems and generate applications to offset the decline. Use these strategies and others to stay on top of your loan portfolio as the economy fluctuates. For questions, please contact Alan Najjar.

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