October 17-21 is Risk Awareness Week, so there’s no better time for credit unions to reflect on their risk assessment practices for commercial real estate (CRE) lending. This includes what their risk appetite is given the current financial climate.
Brianna Vaughan, Extensia Financial’s EVP of Operations, states, “It’s important for credit unions to regularly assess their processes and procedures that address risk management. Mortgage lending in the commercial real estate industry has its own unique risks, even though the industry shows healthy signs of continued growth. So, credit unions must not overlook their credit risk management practices as a staple in their efforts to mitigate loan loss.”
Let’s take a look at the steps credit unions can take to lower the risk of their CRE lending activities.
1. Identify Risks
The first step to mitigating the risk of commercial mortgage loans is to identify all the risks that credit unions face with these transactions. The main risks CRE lenders must manage include, but are not limited to:
- Credit risk
- Interest rate risk
- Liquidity risk
- Inflation risk
- Compliance/Regulatory risk
When they’ve identified the top risks to and within their own organization, CRE lenders can rank which ones pose the most threat to their operations.
2. Find the Source
After taking a look at the main risks of CRE lending, lenders can dig deeper to pinpoint the primary source of concern within each identified area. For example, they may identify a primary risk is due to exposure from certain clients and/or regions, or maybe they learn a certain loan product is the culprit.
In any case, finding the root cause of exposure is necessary, and can help credit unions identify areas for improvement within their own due diligence processes as they make credit decisions.
3. Measure and Evaluate the Risk
Commercial real estate lenders need to find a way to measure the risk of their portfolios before moving on to risk mitigation.
Most accomplish this through stress testing their portfolio with interest rate changes, or checking for concentration by industry, region or borrower. This will give lenders quantitative data about the risks they face, which can be helpful when comparing against objective benchmarks and creating a mitigation plan. This type of rigorous evaluation must be done both on individual CRE deals, as well as on an ongoing basis with the entire portfolio.
4. Risk Mitigation
After credit unions understand where their largest risks lie within CRE lending, and have created a rubric to measure and evaluate these risks, they can move on to develop and enact a mitigation plan for their unique scenario.
Based on what is learned by completing the aforementioned steps, and as a way to mitigate risk, lenders may adopt a plan that could require certain requests for financing, including additional collateral or an outside guarantee.
On the other hand, lenders may pursue SBA-guaranteed loans as a great way to minimize the risk associated with lending to a small business with limited business history or inadequate capital.
Lastly, diversifying the overall CRE lending portfolio, including assets, geography and beyond, is a classic way to manage risk.
5. Ongoing Monitoring
Above all, it’s important for credit unions to understand that risk management isn’t over after a transaction is closed. They must also monitor their portfolio over time, keeping an eye on delinquency rates, collateral valuations, and the ongoing strength of the borrower and personal guarantors.
Adopting each of these steps into practice, credit unions will be better off with their lending risk management and have a healthier CRE portfolio.
About Extensia Financial
Established in 1998 and headquartered in Simi Valley, CA, Extensia Financial is one of the most seasoned credit union service organizations (CUSO) focused on commercial real estate lending. We partner with credit unions to connect them to commercial real estate investors across the United States. For decades, we have offered competitive and collaborative loans and uniquely support and guide our partners through the entire lifecycle of our loans. Extensia Financial is a proud member of the AVANA Family of Companies.
Contact us today to learn more about becoming an Extensia Financial partner.