If you think the economy is going to muddle along, then you should skip this post as our analysis isn’t going to make a difference in your future - 2021 will be much the same as 2016. However, if you think the economy is going to pick up steam, or if you think the economy will get weaker, then today’s data could make a difference over the next couple of years. As can be seen by the graph below, commercial real estate risk continues to increase and the risk on new community bank loan production is up 6.5% during the first half of this year compared to last year.
Tag: Credit Management
We are in agreement with the ICBA that FASB’s proposed current expected credit loss (CECL) model would place tremendous costs and regulatory burdens on community banks. We also agree that CECL, as proposed, will increase reserves and negatively impact many community banks’ ability to lend and support economic growth through lending. However, it does not appear that the current proposal will be modified for banks under $10B in assets. We believe CECL will fundamentally change community banking, but some of those
We always like to look back and see where underwriting and credit accuracy can be improved. Recently, we looked at almost 5,000 commercial real estate (CRE) loans from across the country that was underwritten in 2012. We looked at the property level cash flow projections to include revenue, expenses and net operating income (NOI) and then compared that to what has actually happened over the last 3 years. Our findings should give you some comfort to the conservative nature of your average underwriter.
Bankers are lamenting the current ridiculous low loan spreads and questioning if they are getting appropriately compensated for the risk that they are taking with their capital. This brings up the question - Are banks getting compensated for all of the risks that they take for extending credit? Our resolute answer is - no, bankers rarely get sufficient revenue for the risks that they take in lending.
Having more bankers to throw at a borrower or more assets to flaunt does not make a bank more effective. Strategy beats size every time, but bankers need to be smart how to position themselves against large banks. When it comes to loan mix, community banks need to be careful to assemble their assets with enterprise risk in mind. In particular, the increase in commercial real estate (CRE) and specifically, High Volatility Commercial Real Estate (HVCRE) is starting to be a concern.
On Monday, we made the comment that when the Fed Funds rate goes up (and hence the Prime rate), loan quality usually improves during the short run. Some of you wanted to see proof of this, as the notion is counterintuitive as higher rates usually place strain on debt service coverage for floating rate loans. Today we present the empirical data as well as an explanation on how rates and credit risk is correlated.
Earlier in the week (HERE) we equated community bank credit ratings to toenails and substantively showed community banks the current probabilities of default for commercial real estate (CRE) by credit risk grade. We discussed how banking is becoming more quantitative and how when rates go up, it will be the bank that correctly classifies credit, allocates capital and correctly prices risk that will have a distinct advantage.
If truth be told, community bank credit ratings are like toenails. You see them a lot, you occasionally think about them, every now and then you maintain them, you make sure they look good when you know they are going to be seen, and you only have a vague awareness of their practical use. The underutilization of community bank credit ratings is about to change over the next five years as rates go up and more sophisticated models help bankers get more quantitative about how they classify credit, price risk and allocate capital.
The 20’s and 30’s were known as the Golden Age Of Aviation and today is a particularly special day in aviation history as it marks the 88th anniversary of Charles Lindbergh becoming the first person to fly across the Atlantic and the 83rd anniversary of Amelia Earhart doing the same in the first female solo transatlantic crossing. In similar fashion, we are in the Golden Age Of Commercial Credit and today marks the day when commercial credit has never been better in the history of banking.
For many banks, loan structuring is a one size fits all effort. Like Henry Ford said about the Model T –Customer can have any color they would like in the car as long as it was black, banks say that their value proposition is service, yet offer few choices when it comes to loan structuring. The reality is, to best match the risk position of the borrower, banks first need to understand a borrower’s asset-liability position and then structure the loan in such a way as to mitigate a variety of risks including credit, liquidity and interest rate.