Bank policies minimize risk
he year 2020 won’t be like the year 2008, thanks to the year 1992, because... standards.
And if you were a banker or a savvy onlooker back in 1992, you probably already know what I’m talking about.
Austerity and corporate self-reflection rendered wisdom.
Toil and trouble taught our corporate real estate guru’s that: “In real estate lending, we just don’t earn enough in the good years to make up for the losses in the bad years.”
This pain inspired internal regulation which has served us well in real estate cycles since then, including a list of things for which no exception could ever be granted. Period.
Real estate project financing today has significant checks and balances to help mitigate risk.
This includes, but is not limited to: feasibility studies, appraisals, required pre-selling of portions of projects and sufficiently verified owner’s equity.
We also require additional cash or near-cash resources in the hands of the owner to satisfy a margin of error and cash calls in the event of cost over-runs. The owner’s down payment goes in first.
No bank draws are provided until the bank is satisfied at each step that the project is progressing on target.
We also set absolute limits on loans to connected entities, sharing (syndicating) risks with other banks once size restrictions are about to be breached. We place caps on loans to the same sector on a bank-wide basis.
And of great interest in today’s low-rate environment, we test loan debt service capacity of borrowers against potential increases in interest rates over the life of the loan. So if rates go up, we have already pre-tested the loan against the higher rate beforehand.
So, as I say to my clients today, if a small financial institution is inviting you to bring your deposits over, offering significantly higher interest rates than the market, ask yourself why. What sorts of loans are they making with your money? Are their risk management policies sufficiently sound?
Mark Ryan is an investment advisor with RBC Dominion Securities Inc. (a member of the Canadian Investor Protection Fund). This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. Ryan can be reached at mark.ryan@ rbc.com.