My last blog covered five steps you should consider to promote diversification and/or alleviate a portion of the credit risk associated with real estate concentration.
Here are a few more as we look at managing a Commercial Real Estate (CRE) portfolio:
- Adopt or strengthen regular portfolio management practices (“early warning systems”) that can proactively identify a deterioration in operating performance or other various factors that can be indicative of added risk shifting to the lender. The use of internal “triggers” enables the Loan Officers to engage in meaningful conversations early as opposed to after the fact when, in many cases, it can be too late and conversations/negotiations can turn contentious. Covenants are binding between the bank and the client, but by the time they are violated there likely is already a problem. Internally tracking those same covenants (or others) at tighter levels simply to “trigger” the meeting and discussion with the client, can tend to lead toward more desirable results on both ends. Nobody likes surprises, especially banks. This practice is intended to work more proactively, and can help to reduce surprises.
- Adopt portfolio stress testing capabilities and procedures which can efficiently model interest rate spikes, declines in property values/changes in cap rates, occupancy deterioration, identify concentration(s) of certain national or regional tenants, and aggregate the type and location of collateral.
- Perform routine site visits, field audits, and internal policies defining criteria that would require an updated appraisal.