Understand all risks involved with the deals you are pursuing.
Are your controls to measure risk as robust as they should be in today’s environment?
When the lending environment changes you need to be ready.
Prepare for the next cycle by being aware of the following:
Identify your borderline credits.
How many do you have that are performing but sensitive to economic hiccups. When hiccups occur what loan types in your portfolio leave the largest amount of exposure?
Loan segmentation should regularly be applied based upon your comfort level and that of your institution. If the need is there to re-align your credits then move those not meeting risk levels to increased rates.
Plan for interest rates and cap rates to change.
Make sure to apply stress testing to portions of your portfolio for scenarios of interest rates and cap rates increasing. Underwrite for a higher interest rate to better understand your risks.
To neutralize both variables it is suggested to run a Debt Yield: Debt Yield = Net Operating Income/ Loan Amount. Based on these results determine if there is still positive cash flow.
Understand the ‘deal creep’ that can occur.
Enlist the process of looking at potential clients in terms from your first meeting to what the terms are when/if they close. How many exceptions are being made to get the deal done? Is your institution consistently comfortable with that amount? At what point are you willing to walk away from the deal?
Set exposure limits and do not exceed those limits. Internally, it would be good to post green, yellow, and red lighted loans taking place each month to lenders in your institution to assist them with determinations.
The ‘What’ and ‘Where’ matters for diversification.
Think about how economic downturns can affect certain concentrations by different factors. For example, if a majority of your deals are in the same geographic area and that area is highly volatile to economic downturn it would be wise to focus some of your efforts in a drastically different geography to off-set.
Also, if your portfolio is highly concentrated with retail it is important to understand your tenants and their volatility. Understand your exposure of getting that one big deal versus having several smaller, more diversified deals.
Transparency and measurement are a must.
NOT INTENDED TO PROVIDE LEGAL, ACCOUNTING OR OTHER PROFESSIONAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH.