Pub. 16 2021-22 Issue 6

Counselor's Corner — continued on page 18 IF YOU ARE A COMMERCIAL OR agribusiness lender, it’s likely been a while since you had a significant number of defaults in your portfolio. I wish I could tell you it’s because your borrowers are all financially healthy and operationally disciplined. Unfortunately, borrower distress and problem loans have not been eradicated from commercial and agribusiness lending. They’ve just become much harder to diagnose. A much better explanation for the lack of defaults is that a decade-long bull market and historically lowinterest rates drove up asset values and created a lot of investor-class wealth. This, in turn, caused a massive influx of private money into the financial system, increasing competition among lenders and shifting the balance of power in favor of borrowers. Eventually, even small- and middle-market businesses found themselves able to borrow more than they ever had before. And borrow they did, with many of these businesses using their increased liquidity for controlled, sustainable growth. Many others, however, used it to cover up the effects of their poor business decisions, personal misfortunes and even fraud. When the bull market ended in March 2020, it briefly seemed like the jig was up – that borrowers secretly in distress would finally be unmasked. But then, an unprecedented amount of government financial assistance in response to the COVID pandemic was indiscriminately doled out to good and bad businesses alike. The market rebounded and thereafter has remained robust. In short, the jig was not up, there was no unmasking, and to this day, many unprofitable and overleveraged borrowers continue to look from the outside like good businesses with low risks of default. Now I could tell you a down-cycle is imminent – that it’s only a matter of time before you start seeing a sharp increase in defaults as a result of supply chain disruption, interest rate hikes and growing inflation driving up the cost of doing business. But frankly, no one can say with any certainty when the next downturn will happen. Plus, I bet by now someone like me has been telling you “this is the year the music will finally stop” for at least five years running, and you’re understandably sick of hearing it. Instead, let’s assume the music keeps playing for a while, and as long as it does, the default rate in your loan portfolio remains very low. This period – from today until the next wave of defaults finally arrives – presents a golden opportunity for you to nip potential problem loans in the bud before they cause you actual problems. The challenge, however, is determining which among all the performing loans in your portfolio should be labeled as “problems” and given your attention. Because of high liquidity levels and greatly appreciated asset values, historical indicators of distress such as payment defaults and blown leverage ratios can no longer be relied on as early warning systems. Without new, more effective strategies for identifying those borrowers most likely to default, commercial and agribusiness lenders are taking on materially greater risk than you were ten, five or even two years ago. Here are five strategies you can use to effectively mitigate this additional hidden credit risk: 1. Take advantage of available opportunities to enhance collectability. To state the obvious, it’s not a viable lending practice to start requiring additional credit support from borrowers at a time when they are making all required payments and NEBRASKA BANKERS ASSOCIATION 17

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