Building Relationships, Not Risk: How Banks Can Navigate an Uncertain CRE Market

More than four years have passed since the start of the pandemic and the CRE market is still riddled with uncertainties. Despite the cloudy outlook for CRE lending, there are undoubtedly opportunities for the banks that can balance both risk and growth in this market. 

The right approach to managing risk can ultimately help banks build lasting commercial relationships that stand strong in any economic climate. 

There are several contributing risk factors impacting the CRE space. For one, the office space sector continues to face challenges. Office attendance in major urban areas is still roughly half of what it was pre-pandemic. Meanwhile, vacancy rates in office buildings are reaching new heights, with the national average now at 13.3%, according to CoStar Risk Analytics, which was cited in a recent RMA blog post.
 
These hurdles are expected to continue through 2026 and to accurately assess risk, lenders are having to pore through a variety of details and data points about individual properties. Not to mention find ways to then mitigate those risk factors. 

This is where it can get even more challenging. Regulators have asked lenders to work with borrowers when they can and are asking lenders to differentiate risk factors, which can be difficult and time-consuming without granular and well-organized information. 

Some banks will struggle, but those that stay on top of risk will weather the storm and foster loyalty with valued commercial customers, gaining a competitive advantage that’s tough to beat. Adopting some best practices will make this possible for banks of all sizes to achieve. 

Stay on Top of the Data

Staying on top of the data and working with the borrower gives lenders the necessary information to help the client and protect the bank. Banks should know their clients exceedingly well, both at onboarding and throughout the evolution of the relationship. This requires gathering complete and relevant information about the borrower from the outset. Not only that, but data should also be centralized so it’s a reliable resource for the bank’s decision makers. 

With up-to-date and well-organized data, banks can more objectively and consistently assess risk according to the institution’s policy. This makes it much easier to identify risks as they materialize across products, business lines, and clients and use these risk measures to maintain appropriate margins through the life of the credit while also best serving borrowers.

Stress Testing is Crucial

Clean, structured data is also the foundation for improved stress testing. Today’s banks have more information available to better understand commercial relationships and various trends impacting them. Strong stress testing sheds light on those trends and can reveal opportunities to proactively respond to risks before it’s too late, oftentimes by doing loan workouts. 

In fact, last year, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp. and the Fed, as well as the National Credit Union Administration — issued a policy statement on CRE workouts and accommodations to help “creditworthy borrowers during times of financial stress,” updating previous guidance from 2009, as cited in a Bank Director article. 

The policy document features multiple examples of CRE workouts, including a scenario examining an office building negatively affected by remote work. It presents how banks can avoid criticism by their regulators in workouts through actions such as analyzing the borrower’s global debt service coverage, which measures whether the client has enough cash flow to repay debts.

Stress testing is crucial for banks to respond swiftly to scenarios like this and determine what the appropriate action should be to minimize losses. It’s important to be prepared for various scenarios, which is why it’s recommended that banks use numerous stress testing variables, including interest rates and loan types as well as concentrations. 

Strong Collateral Management

Last but certainly not least, strong collateral management is essential to managing risk and ensuring compliance in an evolving CRE market. 

“As a line of defense against loss, bankers will want to monitor collateral value closely. This is especially true for real estate. While real estate collateral is often considered high value due to its relatively stable value, easy marketability and readily ascertainable value, during the last few years, evolving workplace and retail patterns have left the stability of real estate values in question. Therefore, regular assessment of borrowers with substantial real estate collateral will be critical,” said Amanda Yoder, in a recently published ABA Banking Journal article.

Yet, some banks still manage collateral manually, oftentimes as a notation or comment on a loan detailing the collateral securing it. For large commercial customers, an individual piece of collateral may secure multiple loans and the bank may create a separate record for that collateral. This approach makes it incredibly difficult to parse information for reporting and ultimately, proactive risk management. 

Instead, banks should look for technology that assists in managing all you need to track, starting from the initial loan request to collateral tracking and beyond. With commercial customers often having multiple entities, guarantors and loans, tracking everything required to prevent the institution from being at risk is complex. 
Software that allows one tracking item to be tied to client, collateral, product, and opportunity levels provides a more comprehensive view of risk and the best path forward. Strong collateral management and exception tracking workflows makes it much easier for banks to address shifts in collateral values in a way that ensures compliance with their institution’s policies and risk profiles – all while maintaining strong relationships.

Author Bio

Baker Hill empowers progressive financial institutions to increase revenue, reduce risk, and drive more profitable relationships.

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