How Financial Institutions Can Make Their Commercial Real Estate Portfolios Crisis-Proof

How Financial Institutions Can Make Their Commercial Real Estate Portfolios Crisis-Proof

Over the last few weeks, nonessential businesses across the United States have temporarily closed their doors to help mitigate the spread of COVID-19. For many business owners, this has imposed several economic challenges.

Even as retailers, restaurants, warehouses and office parks are shut down, most are still required to pay rent. According to the Wall Street Journal, giant retailers including Petco, Staples and Dick’s Sporting Goods are falling short on their April payments, which doesn’t bode well for the $20 billion in rent payments that are due in May.

As rents payments are skipped, suspended, deferred, or reduced during this time of economic hardship, financial institutions could see an increase in defaults and foreclosures on commercial real estate loans. This means banks and credit unions need to be able to identify which of the loans in their portfolios are at risk of default, so that they can proactively address that risk.

Because most state lockdown orders began in March, and because borrowers typically have to miss several payments before they are considered delinquent, many financial institutions will not have a clear idea of which accounts are at risk until it’s too late to respond. This is a problem for financial institutions, many of which must manually sort through their portfolio, guess which accounts might be impacted, and then forecast or project financial models and losses.

Financial institutions must instead find ways to be proactive, so they can offer their customers’ support when they need it rather than waiting until payments are 90 days past due and options are more limited. A good place to begin is by utilizing technology to implement the following three strategies.

1. Drill into specific hot spots.

As the economic crisis continues to evolve, certain demographics, sectors and geographies will emerge as “hot spots”. The sooner a financial institution can address these hot spots, the better. By implementing an efficient Commercial Real Estate (CRE) Solution, for example, financial institutions can configure fields to track demographics on subject properties and tenants, such as by NAICS codes.

As a recent American Banker podcast pointed out, commercial real estate tends to make up a larger portion of community banks’ portfolios and have a larger impact on smaller cities and towns. These also tend to be areas where industries are more homogenous, such as communities that are driven by tourism or manufacturing. If those sectors are hit particularly hard by the pandemic—and many of them are—then the risk to the community bank is even higher.

Meanwhile, when it comes to national retailers, not all stores will feel the same impacts. For example, a nonessential business like a sporting goods store will feel a greater impact from closures than essential businesses like grocery stores. By proactively addressing and reporting relevant information on hot spots and potential issues, financial institutions can stress particular properties through multi-variate sensitivity and advise their customers accordingly.

2. Assess portfolio health by looking at potential impact.

Financial institutions must be able to stress properties on both macro and micro factors with CRE solutions. Multi-variate sensitivity analysis allows banks and credit unions, for example, to stress a property to see what would happen to net operating income if vacancy rates increase, which is likely happening right now with tenants closing their doors and the uncertainty around when they might be able to reopen.

An important thing to remember about this crisis is that most borrowers were in good standing before COVID-19’s disruption. Stores are closing not because business is slow or they made poor financial choices, but because of local and federal mandates, as well as a sense of duty. It is in the financial institution’s best interest to take care of their customers during these difficult times so that when things get better, those same customers will not leave them for a bank that treats them better. By stressing properties and proactive communications on both short- and long-term impacts, both the financial institution and the borrower will benefit.

3. Aggregate exposure across the portfolio

Unfortunately, not every business will survive the current crisis, and financial institutions need the ability to quickly analyze the impact to their portfolios when a company announces it is going out of business.

As such, it is important financial institutions adopt technology that automatically populates data models when tenant information is entered.This will allow financial institutions to not only run reports on specific properties, but to more importantly run reports on tenants to see all the properties and borrowers affected by a company going out of business. Relationship managers can reach out to the borrowers to help form a new plan of action to fill the space or find new tenants.

As market conditions continue to change day by day and, in some cases, hour by hour, it’s become clearer than ever that legacy systems and Excel sheets cannot meet the needs of today’s markets. To remain competitive, financial institutions must find fast, flexible and efficient ways to serve their customers, monitor economic impacts and protect their assets. Financial Institutions must lean on solutions that incorporate a single platform and a flexible data model that can offer a deeper understanding of their portfolio and a stronger relationship with their customer.

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