CRE Lending Best Practices

Transcription

1 CRE Lending Best Practices Understanding the risk and rewards P R E S E N T E D B Y Rob Ashbaugh Executive Risk Management Consultant Sageworks

2 Disclaimer This presentation may include statements that constitute forward-looking statements relative to publicly available industry data. Forward-looking statements often contain words such as believe, expect, plans, project, target, anticipate, will, should, see, guidance, confident and similar terms. There can be no assurance that any of the future events discussed will occur as anticipated, if at all, or that actual results on the industry will be as expected. Sageworks is not responsible for the accuracy or validity of this publicly available industry data, or the outcome of the use of this data relative to business or investment decisions made by the recipients of this data. Sageworks disclaims all representations and warranties, express or implied. Risks and uncertainties include risks related to the effect of economic conditions and financial market conditions; fluctuation in commodity prices, interest rates and foreign currency exchange rates. No Sageworks employee is authorized to make recommendations or give advice as to any course of action that should be made as an outcome of this data. The forward-looking statements and data speak only as of the date of this presentation and we undertake no obligation to update or revise this information as of a later date. 2

3 Agenda CRE Loan Origination Best Practices: Parties involved in the real estate transaction What documents to request and who to request them from Metrics and ratios to analyze, and spotting potential red flags How to Compete and Remain Profitable: Specializing in a specific real estate vertical Loan pricing strategies for competitive environments Reducing turnaround times and improving efficiency CRE Loan Portfolio Management: Stress testing best practices for CRE Methods of stress testing for concentrations and relationships, Management reporting for commercial real estate 3

4 Why Are We Talking About CRE Best Practices? Why are we talking about this?» Standards are loosening at community banks, mainly underwriting» Regulators are scrutinizing CRE portfolios more heavily» Regulatory pressure is hurting growth and profitability» Banks and Credit Unions are STILL looking to grow CRE portfolios What are regulators looking at?» Asking about stress test practices (OCC Requirement)» Strength of risk rating practices» Underwriting guidelines» Policies and procedures» Concentration reporting 4

5 Standards Loosening at Community Banks 5

6 Standards Loosening at Community Banks Our exams found looser underwriting standards with less-restrictive covenants, extended maturities, longer interest-only periods, limited guarantor requirements, and deficient-stress testing practices. -OCC July

7 Regulators are scrutinizing CRE portfolios more heavily Federal banking regulators put banks on notice that they were going to be taking a closer look at CRE loan concentrations -- CoStar News 7

8 Regulatory pressure is hurting growth and profitability For local banks, regulators pushback over commercial property loans means another squeeze on growth and profitability that is likely to lead to further thinning of bank numbers -- NY Times 8

9 Banks and Credit Unions STILL looking to grow CRE But many banks are able to boost their CRE lending, despite high concentrations, because they followed regulators' orders to upgrade their credit-analysis procedures, internal controls and software -- American Banker 9

10 Banks and Credit Unions STILL looking to grow CRE Which area of the loan portfolio is your biggest focus for growth? 10

11 Institutions can reduce scrutiny with best practices Regulators said that their supervisory evaluations wouldn t be based on numbers alone but would be mitigated by the overall strength of a bank s lending and risk management practices. -- CoStar News 11

12 CRE Loan Origination Best Practices Part 1 Parties Involved Required Documents Metrics to Analyze HVCRE

13 CRE Loan Origination Best Practices Parties Involved Required Documents Metrics to Analyze HVCRE Parties Involved» Bank» Borrower/Developer» Bank s attorneys (in-house or external)» Borrower s attorney» Guarantor, if applicable» Equity contributor, if applicable» Everybody else Appraisers Brokers Title insurance Environmental consultants Engineers/Contractors Insurance companies Local authorities (planning, code, etc.) 13

14 CRE Loan Origination Best Practices Parties Involved Required Documents Metrics to Analyze HVCRE Required Documents General CRE Loans: 3 years of operating statements Guarantor financials Copies of all leases Rent rolls Subordination, Non-disturbance and Attornment Agreements (SNDA) Plat surveys Environmental Phase 1 and/or Phase 2 certificates, as appropriate Title insurance policy Property Assessment Report Sources of equity contribution General contractor financials Certificate of Occupancy Specific to Construction Loans: Assignment of construction documents Fixed price or guaranteed max construction contract, depends on loan size/project value Larger deals should have a 3rd party engineer review of contractor Assignment of leases 14

15 CRE Loan Origination Best Practices Parties Involved Required Documents Metrics to Analyze HVCRE Required Documents Benefits of using digital docs vs originals» Can be uploaded, meaning increased turnaround time on underwriting» Do not need to be mailed» Can be digitally signed» Do not need to be copied and archived» Long term storage is easier and more accessible» Easier to collect documents from multiple sources Minimizes or eliminates trailing docs issue 15

16 CRE Loan Origination Best Practices Parties Involved Required Documents Metrics to Analyze HVCRE Metrics to Analyze Back to the Basics» Debt Service Coverage Ratio (>1.2)» Loan-to-Value and Loan-to-Cost (generally <75%)» Debt Yield (>10%) generates return to the bank» Other metrics to consider: 5 C s (character, capacity, capital, collateral, and conditions) NOI (stabilized and unstabilized operation) Cash in cash return (equity dividend rate) Cap rate Debt ratio 16

17 CRE Loan Origination Best Practices Parties Involved Required Documents Metrics to Analyze HVCRE Metrics to Analyze Debt yield (Net Operating Income / First Mortgage Debt) * 100 Advantages» Increasingly being used by banks in lieu of DSCR Structure and term can make any DSC look good» Generates a return for the bank if it forecloses Disadvantages» Causes loans to be smaller to generate a larger return» Use this ratio as a best practice even if not required 17

18 CRE Loan Origination Best Practices Parties Involved Required Documents Metrics to Analyze HVCRE HVCRE (High Volatility Commercial Real Estate) BASEL III Defined as all Acquisition, Development and Construction (ADC) loans or real property, prior to perm financing unless:» 1 to 4 family residential projects» Investment in community development project» Agriculture» ADC Loans that: Meet regulatory LTV ratios, cannot exceed maximum regulatory limits Borrower has invested equity, at least 15% of appraised as completed value AND borrower capital cannot be taken out until converted to permanent financing, sold or paid in full HVCRE Lending Implications:» HVCRE loans should be assigned a 150 percent risk weight for reserves, adding 50% more to your allowance» Has significant impact on the amount of construction loans, it is more pricy» Increases borrowing rates for HVCRE borrowers» Forces developers to increase capital contributions 18

19 How to Compete and Remain Profitable Part 2 Specialization Loan Pricing Strategies Improving Efficiency Construction Loans

20 How to Compete and Remain Profitable Specialization Loan Pricing Strategies Improving Efficiency Construction Loans Specialization Look for niche asset types or niche markets» Focus on a specific vertical like suburban office, hotels, apartments etc.» Example: Current Sageworks clients specialize in medical office, franchise and even summer camps Specialize in unique loan structures Concentrate on certain geographic areas, not just MSA or Zip Target smaller properties Use limited recourse debt STICK TO WHAT YOU KNOW Opportunity: CMBS deals from 2006 that need to be refinanced, pre-recession deals Advantage: Local expertise to get in front of clients and projects early Advantage: Banker and borrower both benefit from a standardized lending process» Each property type or loan product should have a lending process unique to itself 20

21 How to Compete and Remain Profitable Specialization Loan Pricing Strategies Improving Efficiency Loan Pricing Strategies Loan must be appropriately priced based on risk» Loans with high LTV and low debt service coverage ratios should be priced higher to account for charge-offs» Probability of Default/Loss Given Default (PD/LGD) matrix automates the risk portion of Loan Pricing» High loan prices allow the bank to put more money into ALLL augment capital to support risks being taken» Don t assume too much risk without being paid for it Pricing the present value of cash flows vs traditional spread-based pricing Construction Loans» Captures lifetime return in todays dollars» Determines the minimum rate at which the bank makes money 21

22 How to Compete and Remain Profitable Specialization Loan Pricing Strategies Loan Pricing Strategies Improving Efficiency Construction Loans 22

23 How to Compete and Remain Profitable Specialization Loan Pricing Strategies Including the relationship in your pricing» A relationship might be worth a BP pick up in pricing. Loan Pricing Strategies Improving Efficiency» Don t be afraid to ask for deposits and services, it can be treasury management, IRA, etc.» Having multiple products with the same customer decreases the marginal cost of each product Construction Loans 23

24 How to Compete and Remain Profitable Specialization Loan Pricing Strategies Improving Efficiency Improving Efficiency Reduce turnaround times and improve efficiency» Use electronic documents» Automate underwriting to quickly see results» Make requirements known up front» Only ask for documents that you actually need/use» Leverage software to connect and automate processes Construction Loans 24

25 How to Compete and Remain Profitable Specialization Loan Pricing Strategies Improving Efficiency Construction Loans The Loan Administration process for construction is likely one of the more time consuming and tedious processes for banks» Have an efficient construction administration process. Is this process audited and ticklerized? Is this process isolated from the front office?» Consider adding the cost to your pricing model Construction Loans 25

26 CRE Loan Portfolio Management Part 3 Why Stress Test CRE? How to Stress Test CRE Management Reporting Examples

27 CRE Loan Portfolio Management Why Stress Test CRE? How to Stress Test CRE Management Reporting Why Stress Test CRE? Regulators are starting to ask community banks» Small banks not stress testing but doing it as a best practice What else can you use stress testing for? CRE limits Measuring actual risk appetite Setting lending limits Part of the capital and ALM process Examples 27

28 CRE Loan Portfolio Management Why Stress Test CRE? How to Stress Test CRE Management Reporting Examples How to Stress Test CRE Fed concentration stress test recommendations» Shock interest and cap rates Shock to where they think they are going There is correlation showing between cap and interest rates in some markets» Look for correlation between Rental decline Vacancy Cap rate Stress Testing Best Practices:» Board to see at least one comprehensive stress test package per year (OCC)» Institution test and CRE concentration test that measure the expected loss in terms of capital ratios, ALLL and pre tax income (mild and adverse scenarios)» Quarterly concentration tests that measure expected losses for CRE and subsets of CRE (geographic, loan type, property type, etc)» Customer stress test of 20 largest borrowers» Stress all new loans as part of the underwriting process 28

29 CRE Loan Portfolio Management Why Stress Test CRE? How to Stress Test CRE Management Reporting Examples Management Reporting Data quality dashboards/reporting» Origination» By product/property type concentrations» Delinquencies and charge offs» Key risk indicators» Exceptions/FDICIA limits Comprehensive risk assessments» Geographic markets» Specialized lending categories» Specific industries» Concentrations 29

30 CRE Loan Portfolio Management Why Stress Test CRE? Examples How to Stress Test CRE Management Reporting Examples 30

31 CRE Loan Portfolio Management Why Stress Test CRE? Examples How to Stress Test CRE Management Reporting Examples 31

32 CRE Loan Portfolio Management Why Stress Test CRE? Examples How to Stress Test CRE Management Reporting Examples 32

33 CRE Loan Portfolio Management Why Stress Test CRE? Examples How to Stress Test CRE Management Reporting Examples 33

34 CRE Loan Portfolio Management Why Stress Test CRE? Examples How to Stress Test CRE Management Reporting Examples 34

35 CRE Loan Portfolio Management Why Stress Test CRE? Examples How to Stress Test CRE Management Reporting Examples 35

36 Q&A and Contact Information Rob Ashbaugh Executive Risk Management Consultant SAGEWORKS LENDING SOLUTIONS Eliminate data entry with the Electronic Tax Return Reader and core integrations Integrated platform for the customer lifecycle Exclusive benchmarks & risk models to support decision-making Thought leader to help you navigate changing regulatory landscape Responsive service & support from product experts Insight into the best practices & templates used at 1,000+ financial institutions 36

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38 Additional Resources Sageworks.com Learn about Sageworks risk management suite» Sageworks Credit Analysis» Sageworks Loan Pricing» Sageworks ALLL Bank Information Customized bank analysis and targeting intelligence tool Interested in talking with a specialist?» us now: sales@sageworks.com 38