How to Prepare your Lending Organization for the Next Economic Downturn

A recent poll showed that two out of three economists are now projecting some type of recession or economic downturn in 2021. Although we know it’s going to come, nobody knows when. In the meantime, our clients are asking how they can best minimize the impact of a downturn to their loan portfolios. They’re asking, “What can we do now to prepare?”

Bankers who struggled most during the last economic downturn in 2008 got into hot water for two primary reasons: 

  • Aggressive underwriting of higher risk type loans, especially in the commercial real estate area
  • Allowing higher loan portfolio concentrations in certain segments of their portfolios

I always say the past doesn’t equal the future,” said Ty Glenham, Senior Lending Consultant of Profit Resources Inc. “But we can certainly consider the past as we’re preparing for the future.”

The most important thing community bankers can do today, while the economy is humming, is better manage their portfolio risk by reducing the potential for problem loans, according to Glenham. Every community banker operates in a unique market, and it’s important to consider that unique market’s trends. FIs should make a list of the top warning signs that could signal problems with borrowers in their portfolios. For example, are receivables or inventories declining? Are there deteriorating business conditions in the marketplace? Are rent rolls supporting the property or is occupancy decreasing? Has the borrower’s insurance lapsed? Is the borrower maxing out his or her line of credit to cover regular operating expenses?

Strategies that FIs can employ to minimize the impact of an economic downturn include:

  1. Monitor loan portfolios more closely. Focus on trend analysis and risk ratings. Monitor lines of credit trends. Take note of any signals that seem out of the norm. Conduct “post-mortems” on failed credits. Discuss what lessons can be learned from each.
  2. Focus on good relationship portfolio management. Review the top 20 borrowers of each lender periodically to identify trouble signs. Require lenders to visit customers regularly at their places of business. The lender can then determine how business is going and discover challenges early. The earlier the lender knows about the challenges, the more options they have in their arsenal to help the borrower overcome them.    
  3. Do not lower your underwriting standards. When the economy is good, banks have a tendency relax their underwriting standards in both the consumer and commercial arenas. However, when times get rough, problems will be revealed and start to multiply. Make sure when loans are closed, everything is “right.” Minimize any exceptions to loan standards.
  4. Foster good relationships with bank examiners. They are intended to be the bank’s partners, and when they observe that the FI has good credit risk management practices, they can help.  
  5. Make sure you address non-performing loans before regulators do! Avoid “Dead Man Walking” loans. Act to recover cash while it’s still there.

“In today’s competitive environment, community bankers feel the pressure to make the loan and reduce pricing,” Glenham said. “If you have to work too hard to make loan or to make the pricing too sweet, the best advice is, ‘Don’t do it.’”

For further information about lending practices to prepare for a recession, check out these slides.

Profit Resources specializes in identifying profitability improvement areas for financial institutions through revenue growth, cost control, streamlining processes, and effective use of technology. Contact us to learn more about our personalized approach to strategic planning to propel growth and improve profitability.

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