LOAN RISK MANAGEMENT DURING A DOWNTURN: A CALCULATED SCIENCE
As a credit union service organization (CUSO), Extensia helps credit unions navigate the intricacies of commercial real estate lending, and risk diversification is an important part of what we do. Examining the data, trends, and options make our risk management recommendations analytical, methodical and systematic.
Got You Covered on Coverage Concerns
Lapsed Insurance Policies
Lapsed Insurance Coverage should not be overlooked when underwriting or reviewing a commercial real estate loan. The Lender, or their Servicer, must verify that the property that serves as security for the loan has adequate insurance coverage and that premiums are current. Insurance is an area that deserves renewed attention during the COVID-19 crisis. As owners face diminished rental income due to the economic impact of the pandemic, some Borrowers may have to begin making difficult decisions regarding which bills to pay with available cash flow. Some may opt to let insurance lapse, which places the Borrower and guarantor in an unfortunate position if a new tragedy, such as a natural disaster, should also hit the property and further strain liquidity. Reviewing the loan covenants to verify there are no loan defaults helps to ensure that unforeseen issues do not arise at a later date. When Lenders or Servicers make themselves aware of incongruences, it becomes easier to anticipate potential problems and create a plan to mitigate further risk if necessary. Extensia proactively reviews insurance coverage, tax payments, cash flow, and credit reports, and determines if more frequent or off-cycle site inspections are warranted, so appropriate action can be taken.
Delinquent Tax Payments
Delinquent Real Estate Tax Payments to the city or state comptroller alert the Lender and Servicer to take a closer look at property operations and perhaps consider performing property inspection(s) more frequently than the typical annual basis. This closer look is warranted if a property tax installment is late or missed because penalties assessed on past due property tax bills are often quite high and will typically be avoided by Borrowers if at all possible. Additionally, property taxes, if not promptly and properly addressed, are one of a very few legal reasons for which a Lender’s loan can be legally removed from a property. This is why it is so important that the Lender and Servicer be proactive in determining any underlying cause of a missed or late payment.
If a problem is discovered, this is not the time to presume or panic. Instead, it is a time for skillful investigation. Ask questions. Look at the property holistically. Consider the overall cash flow in the Borrower’s portfolio and the depth of any potential impact. Delinquent tax payments can and should be interpreted as a red flag that warrants immediate attention.
Poor Site Inspection Results
Poor Site Inspection Results provide the Lender and Servicer with another indicator that a commercial loan requires a more in-depth review. Lenders conduct a thorough preliminary inspection of commercial real estate before loan funding, but there is sometimes a temptation for some busy Lenders and Servicers to consider overlooking this tool when servicing the loan after funding. Yes, it can be time-consuming to perform site inspections with in-house staff and costly to have a vendor perform the inspection if the servicing portfolio is of significant size. There are also the issues associated with tracking the inspections, reviewing them when they are complete, and following up if deferred maintenance issues arise during the inspection. However, a physical site inspection is an invaluable tool that has the ability to disclose otherwise unreported property conditions: resurfacing needs, interior water stains, obstructions to access and egress, lack of code compliance, etc.
For this reason, physical site reviews are essential in a Lender’s regular reporting because risk invariably increases when assumptions are made and indicators willfully ignored. Site inspection results help answer the question, “What is not being taken care of as it should be?” Additionally, the physical inspection report, more often than not, affirms that competent property management professionals are taking care of the property per the loan covenants. However, should a conversation need to take place with a Borrower, it is important not to delay in reaching out to ask the important questions necessary to determine what is happening at the property and Borrower level.
The Lender and Servicer should expect transparency in communication with the Borrower. A case in point might be a high-net-worth Borrower residing in a different state than the subject property, who must rely on a local property manager. In situations such as this, the Borrower is usually grateful to be apprised of a potentially problematic situation at their property, so they can provide the property manager appropriate direction on how best to handle the asset on their behalf. After the issue is addressed, the Borrower will provide the Lender or Servicer with verification of completion of the repairs or maintenance. The conversation could also go in a completely different direction wherein the Borrower expresses their desire to refinance or sell the property. It’s only possible to facilitate successful outcomes when the lines of communication are open, and the sooner the better.
A loan transaction documents a promise made between a Lender and a Borrower to abide by an agreed-upon set of conditions. In loan documents, these conditions are referred to as covenants.
Loan Covenant Violations
Loan Covenant Violations include any and every incident of Late Payments, Delinquent Real Estate Property Tax Payments, Lapsed Insurance Coverage, Substandard Credit Scores, and Poor Site Inspection Results. All of these violations should alert the Loan Servicer or Lender to take a closer look at both the Borrower and underlying property.