Prepare Your Portfolio for an Economic Downturn

November 12th, 2018

portfolio-11-12-18.pngAs we reach the 10-year anniversary of the inflection point of the 2008 financial crisis, it’s the perfect time to reflect on how the economy has (and hasn’t) recovered following the greatest economic downturn since the Great Depression. If you’ve paid the slightest attention to recent news, you’ve probably heard or read about the speculation of when the nation’s next economic storm will hit. While some reports believe the next downturn is just around the corner, others deny such predictions.

Experts can posit theories about the next downturn, but no matter how strong the current economy is or how low unemployment may be, we can count on at some point the economy will again turn downward. For this reason, it’s important that we protect ourselves from risks, like those that followed the subprime mortgage crisis, financial crisis, and Great Recession of the late 2000’s.

In an interview with USA Today, Mark Zandi, chief economist for Moody's Analytics, explained, "It’s just the time when it feels like all is going fabulously that we make mistakes, we overreact, we over-borrow."

Zandi also noted it usually requires more than letting our collective guard down to tip the economy into recession; something else has to act as a catalyst, like oil prices in 1990-91, the dotcom bubble in 2001 or the subprime mortgage crisis in 2006-07.

As the number of predictions indicating the next economic downturn could be closer than we think continues to rise, it’s more important to prepare yourself and your portfolio for a potential economic shift.

Three Tips for Safeguarding Your Construction Portfolio In the Event of an Economic Downturn

1. Proactively Stress Test Your Loan Portfolio
Advancements in technology have radically improved methods of stress testing, allowing lenders to reveal potential vulnerabilities within their loan portfolio to prevent potential issues. Technology is the key to unlocking this data for proactive stress testing and risk mitigation, including geotracking, project monitoring and customizable alerts.

Innovative construction loan technology allows lenders to monitor the risk potential of all asset-types, including loans secured by both consumer and commercial real estate. These insights help lenders pinpoint and mitigate potential risks before they harm the financial institution.

2. Increase Assets and Reduce Potential Risk While the Market’s Hot
If a potential market downturn is in fact on the horizon, now is the best time for lenders to shore up their loan portfolios and long-term, end loan commitments before things slow. This will help ensure the financial institution moves into the next downturn with a portfolio of healthy assets.

By utilizing modern technologies to bring manual processes online, lenders have the ability to grow their construction loan portfolio without absorbing the additional risk or adding additional administrative headcount. Construction loan administration software has the ability to increase a lender’s administrative capacity by as much as 300 percent and reduce the amount of time their administrative teams spend preparing reports by upwards of 80 percent. These efficiency and risk mitigation gains enable lenders to strike while the iron’s hot and effectively grow their portfolio to help offset the effects of a potential market downturn.

3. Be Prudent and Mindful When Structuring and Pricing End Loans
As interest rates continue to trend upward, it’s crucial that lenders price and structure their long-term debts with increased interest rates in mind. One of the perks of construction lending, especially in commercial real estate, is the opportunity to also secure long-term debt when the construction loan is converted into an end loan.

Due to fluctuations in interest rates, it’s important for financial institutions to carefully consider how long to commit to fixed rates. For lenders to prevent filling their portfolio with commercial loan assets that yield below average interest rates in the future, they may find it more prudent to schedule adjustable-rate real estate loans on more frequent rate adjustment schedules or opening rate negotiations with higher fixed rate offerings (while still remaining competitive and fairly priced, of course).

Though we can actively track past and potential future trends, it’s impossible to know for sure whether we are truly standing on the precipice of the next economic downturn.

“That’s one of the things that makes crises crises—they always surprise you somehow,” said Tony James, Vice Chairman or Blackstone Group, in an interview with CNBC.

No matter the current state of the economy, choosing to be prepared by proactively mitigating risk is always the best course of action for financial institutions to take. Modern lending technology enables lenders to make smart lending decisions and institute effective policies and procedures to safeguard the institution from the next economic downturn—no matter when it hits.

smccarthy

Scott McCarthy is the Vice President of Sales at Built Technologies, leading Built’s sales organization in support of growing demand for Built’s construction lending software.