New Days Require New Ways (Part One)

Posted on September 25, 2020 Published by

This month is the first of two blogs looking at some (potentially) new ways of assessing traditional credit underwriting issues.  In the first article, we look back to a couple of previous blog posts. We discuss how we may need to adjust our focus to account for changes in the current business climate. In other words, New Days New Ways!

Speaking as a “seasoned” citizen, a certain amount of my youth was “misspent” with an affinity for Jimmy Buffet music.  One of my favorite songs, although not widely recognized, was entitled “Growing Older but Not Up”. I used to think it was just clever.  Now I think it is a bit reflective.

The first verse begins “I rounded first, never thought of the worse, as I studied the shortstop’s position.  Crack went my leg like the shell of an egg, someone call a decent physician…I’m growing older but not up…”.  I am quite sure that no one will mistake Jimmy Buffet for a modern day Plato or Socrates. But I could extrapolate some “pop psychology”. This would warn us that we should not continue to do things the way we used to do things if circumstances have changed.

New Days New Ways

In the case of Jimmy and me, it is because of age.  For credit and lending professionals, in view of the COVID pandemic, the commercial lending and business climate has changed. We may need to adjust how we look at and analyze that new reality.  That is not to suggest that the underlying five C’s of credit have changed only; how we may need to supplement or adjust our due diligence.

In our February, 2016 blog “To Be Stabilized or Not To Be Stabilized” we challenged credit and lending professionals to be critical in using the most appropriate appraisal value for a given real estate project or transaction in determining loan to value (LTV).  Should one use “As Is Condition”, “As Completed” or “As Stabilized”?  The caution to the lending institution was to use the value that best represents the current market value.  The temptation, of course, would be to use the “As Stabilized” value for a construction/renovation project because it would allow the institution to lend more within policy guidelines.

What Will Change?

In our new COVID-impacted world, this could be a risky approach if the project is not at a stabilized level. Or, if there is not a current reasonable expectation for the project to achieve stabilization conditions per appraisal assumptions.  Previous assumptions used in an appraisal may have changed as more companies find that they can embrace employees working from home.

The result may be a lower demand for brick and mortar and lower rent for office space.  Market demand may decline and reduce values in areas that were impacted by riots, looting, arson and general civil unrest.  Buildings occupied by small businesses will take longer to come back (if at all). Longer-term unemployment may result in higher vacancy and delinquency rates in multi-family housing.  Government actions may limit evictions and foreclosures, while will make values fall.

Appraisal Evaluations

One thing to look at is appraisal evaluations for renewals and extensions. Look back over the last couple of years and see if there is an upward trend that may no longer be relevant in our post-COVID environment.  Credit staff and lenders should closely examine current local market conditions related to occupancy and lease rates and compare to appraisal assumptions.  Renewals and extensions beyond the original lease-up/stabilization period should also compare actual rents to appraisal assumptions.  This may result in a need to obtain an updated appraisal.

The conclusions of that blog may be more relevant today than ever. It concluded that “prudent valuation selection can minimize some likely collateral challenges and also potentially minimize the level of credit losses some point down the road”.  In the current environment of uncertainty, that could be a short road.

Cash Flows

Our October 2017 blog on “Cash Flow Calculations” highlighted the universal understanding of the importance of quality cash flow analysis in credit decisions.  The article examined some common adjustments to cash flow calculations including gains/losses on asset sales. Also, cash value changes in insurance policies, shareholder distributions, and expenses paid by related holding companies (typically real estate or equipment).

One of the adjustments that may deserve additional attention in the current business environment is the use of vacancy and replacement reserves.  Investment real estate properties typically have two cash flows prepared.  The first is an actual historical cash flow and debt service coverage based upon financial statements.  The second is a proforma cash flow based on the current rent roll. It would also include an allowance for vacancies and replacement reserves.

While replacement reserves may have remained relatively constant on a per square foot basis, the vacancy reserve may demand a bit closer attention.  Given potential structural changes in “work-from-home” acceptance, government shutdowns of certain businesses and civil unrest, financial analysis should look closely at upcoming lease turnover, current vacancies and rental rates (not historical) and marketing time.  Vacancy rates and rents are compared to appraisal assumptions. Then, new appraisals should be ordered if there is a significant deviation.

While the previous two topics are by no means revolutionary, the focus for commercial lending and underwriting will remain evolutionary. That, or we may indeed find ourselves growing older but not up. New Days New Ways!


Richard Rudolph is Senior Consultant at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.



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