Managing Commercial Loan Risk in a Pandemic

Addressing Commercial Real Estate Exposure

Last issue, I talked about the importance of fully engaging in a digital delivery channel strategy for your bank.  Identifying gaps, making additional investments, and training employees to assist customers as they make the move to more digital services.  Here’s a link to that article if you missed it: http://bankinginsights.blogspot.com/2020/06/back-to-normal-thoughts-on-digital.html 

This time, I’m going to deviate from my normal focus on the strategic application of technology, and talk to you about potential asset quality issues related to the COVID-19 situation.

Last August, Barron’s commented on the trend toward smaller banks holding more and more of the commercial real estate (CRE) loans in our country. By their account, banks under 20 billion in assets held over half of the CRE loans in this country.  In 2008 through 2010, as the economy began to cool, we saw regulators encourage banks to reserve against loans that were currently performing, because they feared changes in performance as things got worse.  So that we learn from history, I want to point out the potential for similar treatment in coming months and years, based on the impacts on various segments.

The fallout from our country’s reaction to the pandemic have been felt in many sectors.  Some of these sectors may return to “normal” once the virus threat is neutralized, but I suspect that many will not.  Two or three segments come to mind: 

First, office space.  Working from home has been a thing for many years, in selected cases.  Still, many companies held back on full implementation of work from home, for a number of reasons, ranging from technology to management styles. The COVID quarantine has forced the hand of many businesses, and investment in the necessary technologies has created an efficient, workable remote employee situation.  No doubt many companies are rethinking their need for office space.  Those who have invested in buildings will have a longer path to reducing these overhead costs, but those who are leasing space will no doubt begin to investigate ways to shrink their requirements.  In addition, remaining spaces will likely change radically, as they morph into shared offices and areas designed to facilitate in-person meetings or other small group gatherings. The office of the future will be smaller, both individually and corporately.

Walk-in retail is also a concern.  Ordering on line for home delivery, buying online and picking up curbside at the store, and even local delivery options have impacted businesses from hardware stores to grocery to department stores.

We’ve seen a wide variety of responses from the restaurant sector.  Some are thriving, others struggling, a few have closed, probably permanently.  In talking to these customers, you will want to see that they have made efforts to improve and modernize their order taking and delivery infrastructure while striving to maintain an adequate volume of business.  

What Can You Do Now?

Identify current commercial real estate credits with exposure to potentially challenging business types.  Discuss these in detail and try to get a feel for the ones you are concerned about, prioritizing by size of credit, and of course by any that may already be struggling to perform.  

Meet with loan customers to discuss their perception of the exposure, understand lease/rental terms and timing, and generally open a line of discussion to help you evaluate latent exposure.  For retailers and restaurants, you will also want to ask about occupancy, but also about their efforts to make it easier for customers to choose curbside or home delivery, order online, and generally do business in a more convenient, low contact environment.  This may include deals with third party personal shopper and delivery services.  Bottom line is that you need to know they have a plan for the future.

Document your work as evidence to regulators, your board and your auditors that you are attempting to stay ahead of any potential issues.  In some cases, based on the results of your work, consider adjustments to loan loss reserves in anticipation of significant changes in currently performing loans.