Most banks will realize their largest losses from commercial real estate mortgages (CREMs) associated with investor owned (income producing) properties. Hence the extra scrutiny placed on these loans by the regulatory agencies. There are many things a bank can do to reduce this risk.
One thing we DO NOT see many banks doing is monitoring the Net Operating Income (NOI) for these properties. Sure...you may calculate the NOI and DSCR during annual reviews and adjust the risk rating accordingly. However, this is only the first step of what should happen when monitoring these loans.
It is absolutely essential to keep a running track of all properties
where the NOI is insufficient to service the related debt. A simple spreadsheet will suffice. A bank must aggregate all these properties and ensure they do not exceed more than 25% of the bank's capital. There is a high probability of default and loss for these loans, and investing more than 25% of your capital into these loans can be detrimental during an economic downturn.
Once the total exposure on these loans is known, have your loan officers start developing strategies with these borrowers to mitigate your risk. You can ask to exit the relationship; if you have a DSCR covenant on the loan, more than likely the borrower is default. Or, ask for additional collateral on a property that is cash flowing to reduce your risk of loss.
Don't fall under the false impression that with a strong global DSCR, that holding onto a loan where the collateral property does not cash flow is fine. On a short term basis, yes. But on a long term basis, these are the loans that most investors will walk away from first. Once they do, you are now holding on to a collateral property that is not producing the income the appraisal projected, and therefore the value will be much less than what you used to approve the loan. Result...a large charge off that could possibly have been avoided.
Give us a call and we’d be happy to discuss this subject further.
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