August 22, 2019

Why Now Is a Great Time to Prune Your Portfolio

EXCERPT: Issues are creeping up in the lending sphere when it comes to credit quality, which makes now a good time for banks and lenders to review and adjust their loan portfolios.

Commercial borrowers are often heavily leveraged, which banks and lenders need to watch closely should an economic downturn suddenly occur.

Some small and mid-sized banks and credit unions are seeing sporadic incidents of decaying credit quality and have experienced more charge-offs than they'd care to see over the recent past. But are these situations one-offs, or are they turning out to be regular occurrences?

Only time will tell, but many lenders have been seeing an increase in issues with credit among borrowers, prompting them to take a closer look at their loan portfolios to identify signs of weakness that may be compromising the health of their institutions.

Despite sound underwriting practices, many community banks are still seeing the odd credit issues, as well as borrower fraud scenarios.

And while these situations may seem like they're irregular, they're still being spotted, and financial institutions are keeping a close watch on the industry to see if such incidents will become more of a regular occurrence.

Banks and lenders have reason to be a bit concerned over such instances. After all, they still have the memory of the previous recession on their mind and have adopted practices designed to mitigate risk in the near future. And seeing some borrowers -- particularly in the commercial sector -- over-leveraged has made some bankers slightly concerned.

Should such highly leveraged borrowers experience financial trouble following a period of weak profits, they may find it challenging to meet their loan payments. Even the slightest blip on the radar can spell trouble for these types of borrowers, as well as the lenders who hold their loans.

As of right now, it seems as though these incidences of poor quality credit are isolated. But there's always the possibility that this is the start of something that will be seen more regularly, and banks and investors don't want to be caught unprepared should such a trend picked up steam.

Could credit issues be a developing trend in the lending sphere? Regardless of the answer, banks and lenders should take the time to review and prune their loan portfolios.

Houston-based Cadence Bancorp reported $18.6 million in net charge-offs over Q2 2019 after four of its loans went south. Asheville, N.C.-based HomeTrust Bancshares charged off $6 million in loans during the same quarter, and Franklin, TN-based Franklin Financial Network charged off $7.5 million as a result of similar credit issues with borrowers.

The banks claim to have strong fundamentals and have taken measures to control credit. These incidents seem to be unique, and the banks have little reason to believe they'll be dealing with these on an ongoing basis.

Still, banks can't take good credit for granted, and poor-credit loan assets can sneak onto the books if lenders aren't diligent about reviewing their loan portfolios regularly.

Franklin Financial Network, for instance, brought a third-party firm on board to conduct a thorough review of some of its portfolios. And other banks and lenders should follow suit.

It would be prudent for banks to assess their portfolios regularly to pinpoint any issues and handle them swiftly by selling risky assets and making room for more sound loans. Like Franklin, banks can hire an outside consulting firm and loan sale advisor to assess their portfolios to ward off risk. And Garnet Capital has plenty of experience in this area. 

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