Commercial Lending Trends: Balancing Growth with Risk Discipline

As the economic landscape continues to shift, financial institutions face a high-stakes balancing act: capturing market share without compromising credit quality. In this special edition episode, Brandon Smith and Jay Lucas dive into the current state of commercial lending and explore how top-tier lenders are navigating the tension between aggressive growth and rigorous risk discipline.

About Our Guest
Jay Lucas has over 25 years of experience in the financial services industry, where he has gained extensive knowledge in Risk Management, Commercial Lending, SBA Compliance, and has performed billions of dollars in annual commercial credit reviews for Community and Regional Institutions. During the great recession, Jay worked as a contract Investigations Manager for the FDIC, where he performed in-depth financial investigations and expert loan reviews for both bank and regulatory violations.

About Our Host
Brandon Smith, CPA, is a Partner based in the Atlanta office and the Advisory Practice Leader. 

Learn more about our Financial Institution Credit Review services here: https://www.mjcpa.com/financial-institution-credit-review-services/ and Financial Institution Compliance services here: https://www.mjcpa.com/services/consulting-advisory-services/financial-institution-compliance-services/

Transcript

Speaker 01 0:02

Welcome to BeanStalk, MJ's podcast where we are sharing and showcasing our areas of expertise through conversations with practice leaders on their knowledge and experience. At financial institutions, loan portfolios are the most crucial asset group on the balance sheet. They represent an institution's earning assets, but they also represent exposure to risk. So we have specialists at Malden and Jenkins who work with the leaders of financial institutions to help navigate those risks and maximize that value. And I'm very excited today to be joined by the leader of that practice segment, Jay Lucas. Hey Jay.

Speaker 02 0:46

Thank you, Brandon. I appreciate you having me here today.

Speaker 01 0:48

Well, Jay, thank you so much for joining me. And will you do me a favor and just give for our listeners a brief background on your experience and your role at Mauldin and Jenkins?

Speaker 02 0:57

Absolutely, Brandon. Thank you for having me, first of all. But um I'm director of Risk and Advisory practice. You know, I head in financial institution practice as far as the credit and SBA space. Um this is my 30th year, so I have a little bit of a different background. I come from the banking side. I started out as a consumer lender in my early 20s, and I've kind of grown grown up through that process. I migrated into the risk side of things, and and then I had a background in corporate investigations through the last recession. And so I've had a little bit of everything, and so it it kind of opens it up to kind of to grow and evolve and to see a lot of different things in a different light.

Speaker 01 1:34

Well, and let's let's drill into that kind of expertise because you have a tremendous amount of expertise and work with a lot of financial institutions to help them navigate big questions and strategic efforts, especially when it comes to their, as I called it earlier, their most crucial asset group, their loans. So just help me uh drill in a little bit. What are the kinds of services that you offer? The primary ways you're working with and helping financial institutions?

Speaker 02 1:58

Well, the most traditional, or as I refer to kind of the bread and butter, is just traditional commercial loan review. An independent third-party review is what most financial institutions need to get a real understanding of how their portfolio is. You know, those can be performed annually, monthly, quarterly, whatever the case is based on the institution. Um, but that's our primary service. And then obviously we've grown and evolved into the SBA space. SBA is uh is a multi-million dollar a year industry. Um, a lot of compliance around that, and we've got some expertise built into that area. And then we also have a big MA group. So we're very fortunate that we have a very deep bench that we can help in the MA space as far as you know potential acquisitions, whether you're on the buy-sell side, it doesn't really matter. Um, so those are the the three major things that we can assist with.

Speaker 01 2:42

So the overarching loan review, just kind of taking a look at the portfolio, making sure we are where we need to be, but also kind of taking a level deeper where needed, like you mentioned, SBA to see other compliance requirements around this, let's let's focus on those two. Now, is this largely just kind of check the box or or is there more to it than that?

Speaker 02 3:01

Well, there's two completely different approaches. So on the commercial side, it's it's definitely more of a underwriting. We're looking at, you know, how was it underwritten? How is the cash flow analysis? Um, what is the financial reporting on the borrowers and the guarantors or the sponsors, if you will. On the SBA side, it does tend to be a little bit more checklist, you know, because there are very specific documentation requirements. Um, there's certain loan authorizations that have to be gone through. So the approaches are a little bit different, but but the overall reaching aspect is one, am I protecting my guarantee and am I protecting my bank's asset? So it's kind of a hand-in-hand approach on some of them.

Speaker 01 3:37

And then I can't think about loans without thinking about things like covenants and collateral. What where does that kind of stuff come into play with all this?

Speaker 02 3:47

Yeah, covenants, you know, when you when you get into your larger institutions that do a little bit more safe, you know, sophisticated lending, you'll have covenants based on uh cash flow uh liquidity requirements, leverage ratios, debt ratios, things of that nature. And they'll and they'll put these in these loan covenants. And these could be you know event of default triggers. So as part of the review, you know, we're looking at what was what was how is the loan approved and what are those covenants within those loans? Um, and is the client maintaining them? Um so as far as those kind of triggers, those are some kind of easy things that you can look for and to make sure that the institution is, you know, kind of managing the relationship as they spell it out and you know up front.

Speaker 01 4:25

And I've just been curious too, are those pretty standard across all loans, like what kind of collateral is required and what kind of covenants institutions require? Or is that almost like representative of an institution's culture, their geography, or just the specific relationship with a client?

Speaker 02 4:40

Yeah, well, it's it is very different. So some institutions are are kind of you know, you know, check the box as far as the loan policy. Um, did it's commercial real estate loan? Did we margin at 80% loan to value? And that's kind of you know set it forget it approach because we we know what we have. Um when you're doing more, so like South Florida, we've got some large, you know, sophisticated borrowers that have a multitude of businesses that they're in. So covenants are very important, you know, because they're managing seasonality, they're managing inventory levels, a couple of different things. So it really does depend on the institution's credit culture and what the risk appetite is, because it it does change from institution to institution.

Speaker 01 5:15

Yeah, because you know I've met with Robert Stevens, the leader of our CAS group, quite a bit, who does like, you know, uh outsource CFO and fractional CFO type services. And I know he helps a lot of businesses try and get loans. So I figure, you know, it's just kind of interesting to get a peek behind the curtain at how funny institutions work and what the businesses we're working with on that side of the house might be kind of encountering when working with their uh finance institutional relationships. Now, now what I think banks too in all of this, you know, policies and procedures comes to mind. You know, is that something that you pay attention to? It sounds like you kind of have to, based off of what we were just describing. What is your policy around things like a covenant or what kind of cloud to require in different situations? Is that sort of thing pretty well documented or is it just known at an institution?

Speaker 02 5:58

You know, in our space, like any other audit division of the firm, you know, we have a PBC list provided by client. And, you know, so there's you know, there's 15 or 20 things that we're gonna ask for every single engagement. One of them is your loan policy. Um we have to put in our review when if we have a policy, and when was the review? It has to be reviewed annually. Um so as part of that review, some of our clients want us to review the policy in its entirety every year to make sure it's still relevant. Things change, you know, regulatory issues change. And so we the the policy is very important. Um, and it's also very important to ensure that the board's approved it on a regular basis. So we do look at the policy, and then we we do, you know, like I said, we we ask for a lot of different things, but the policy and procedures is kind of the the starting point of any good audit.

Speaker 01 6:38

Well, and that's probably really valuable to your clients too, because because obviously, you know, mandating needing to have a policy that makes sense. And then also best practice, reviewing it every year, that makes sense. But like what are we reviewing it for? What are we considering? So that's where you can come in to help take a look at it.

Speaker 02 6:56

Yeah, so um regulators, you know, they're just like any other, you know, organization. They they have policy changes and shifts, and certain things may be important to them this year, but not important to them next year. So if you've increased your residential construction, you know, is your policy sufficient enough now to that level of lending? Um, if you've started doing more commercial real estate, do you have an environmental policy? Do you even have an environmental policy? You know, so we've actually seen some institutions that didn't even have an environmental policy other than uh we'll consider it. You know, so we do make those recommendations and we do work with them to make sure that their policies are consistent with the type of portfolio because they they evolve over time.

Speaker 01 7:34

Well, I imagine that happens quite a bit where like we just have a complete gap in our policy, like the environmental uh situation you just discussed. Are there other kind of common things you find that are missing from policy that would probably be a good idea to have in them?

Speaker 02 7:47

Well, SBA, you know, so a lot of times they will they will have a um a snippet about government guaranteed lending. And so if you're really going to grow that book of business, I mean some some institutions may only have like five or 10, 15 SBA loans, but if you're really gonna grow that, you probably need to have a separate SBA lending policy. Um so there's certain certain at some point where a 20, 30 page generic loan policy is no longer going to be sufficient, you'll you'll as you grow, you're gonna need to have a CRE policy, you're gonna need to have an ADC policy. So those those are just some of the things where they they're not really deficient, they just haven't evolved as the institution has.

Speaker 01 8:22

Yeah, that makes sense because you're saying earlier too, even just from the you know the loan review perspective, when you get into like different government loans, that adds more compliance we need to keep you know uh in in tune with and in mind. So also consider those and then institutionalize them in policy too. Right. So, Jay, I'm also curious just about like what kind of bank you work with, what kind of financial institution you work with, you know, size, location, geography, all that kind of stuff. Just give me some background on you know kind of who you're typically engaged to help.

Speaker 02 8:52

Well, as a firm, we have clients up to $10 billion in assets. So I mean we we we have some very large institutions we do business with. As far as me specifically in our practice, typically we're gonna deal with $3 billion and less. Um and everybody says, well, how'd you come up with that number? Well, once you get over $3 billion, they tend to bring more of these functions in-house and they'll they'll have their own internal audit group that reports straight to the audit committee. Um, but as far as you know, the the size, I mean, we go from de novo from you know from the efficacy stage when you don't even have that loan policy yet, um, like I said, all the way up to three, four billion dollar institutions we help with. From a practice standpoint, our practice tends to be more national. Uh, we are not a Georgia firm, we're not a Birmingham, Alabama firm. We are truly a national practice. We've got clients in all in Neosha, Missouri, South Florida. We have a client in Illinois, one in Massachusetts, Virginia. Um, so we we do take it more of a national standpoint, which gives us an opportunity to get kind of, you know, really see how the overall banking economy is doing, to be honest with you.

Speaker 01 9:52

Yeah, absolutely. So so De Nova, remind me, that just means the a bank's just getting started, right?

Speaker 02 9:56

Yeah, it's just getting started up to about three years, and they're still considered in that efficacy stage. They're a lot more scrutiny. Um, you know, they have they just raised their capital and they just you know started out landing a little bit. So some are more aggressive than others and have some pretty lofty goals, and some are, hey, we're just filling a need for our community. So we can we can help it really at either one of those levels.

Speaker 01 10:16

And then the real large institutions, it makes sense that they really have to beef up their own internal departments to keep track of everything they need to keep track of. But do you ever find even they reach out to you for help?

Speaker 02 10:27

Yeah, we've had a couple institutions. Uh we actually had one that was uh almost $14 billion in assets. Um they acquired an asset-based lending firm. You know, so they wanted us to come in and look at a targeted review. Uh we helped just, you know, on that particular portfolio to make sure that the policy and procedures were in place, that their, you know, their safety guards matched with the institutions, what they thought they were acquiring. Um but yeah, we we've done some targeted as far as um CRE risk assessments, things of that nature. So when they get over a certain point, you know, if you hit that concentration button we talked about earlier, you know, we'll just come in and say, hey, okay, have your policy and procedures, have you updated them enough to keep the regulators, you know, a comfort level there?

Speaker 01 11:06

Yeah, absolutely. And then really that kind of that bread and butter, that kind of three billion and less kind of target for the full scope of being able to provide a lot of support and value to across the gamut. Now, I am curious, I know you work with uh a lot of financial institutions, like you said, nationally and in all shapes and sizes, but just like is it pretty easy for you to get a sense of like something like credit culture?

Speaker 02 11:28

It is. Um, some are better than others. Um, but no, as as a whole, I mean, the credit culture is pretty easy because like y'all talked about that PBC list, that's things we're asking for from the client. And when you can tell the quality of the reports you're getting, the quality of the information they're providing, you know, because we got to pick a sample. So we're trying to get a loan trial with some specific data points on it. Um, and so we we can't pull those loan trials if we don't have good information. And so you can get a pretty good threshold comfort level up front just on the information that they're providing up front.

Speaker 01 11:59

Yeah. Yeah, I I can see that. Because that's something too, you know. I imagine institutions, you know, sensitive to or should be sensitive to kind of their credit culture. Because as I said in my opener, I mean, this is a crucial asset group for them, both from earnings perspective and a risk perspective. And and on the lines of risk, I'm just curious, do you do you ever like see signs of increasing risk? Just like like indicators that, okay, you know, that's not necessarily directly tied to culture, but just what's what's happening in their operations or activities is kind of leading to, okay, you're moving yourself into a new risk category.

Speaker 02 12:32

Um, we we do see that from time to time. Obviously, you know, you you can look at past dues and kind of get ideas, see where the past dues are going. Um, but as far as, you know, if they're going into a new line of business, did you start doing some marine financing? Did you start aviation financing? Did you get into rolling stock, you know, automobile financing? Um, there's a lot of different things that that should say, hey, we we just we're doing something different. We want to make sure we're looking at it. Um and and then obviously um turnover. You know, did you have um we've we've had several institutions where where we've had a lift out of an entire lending team out of an organization and they just leave and go to another one. Well, that's a portfolio that's no longer being managed. Same time, did you bring in a bunch of new lenders and have you really checked to make sure that they're they're doing what they're supposed to be doing? You know, you so we we we say we we we pick on everybody equally when we do our exams. Yeah.

Speaker 01 13:20

But it probably does help you, you help them know where to focus. You know, when you get a sense of just how easy is it to get the documentation we need to do the services this finance institution needs, and then also kind of what am I seeing? Let's make sure it's not just going through that checklist, but really responding to their environment.

Speaker 02 13:37

Yeah, well, you know, we're very fortunate in the fact that uh I have Joseph McCain who's been on my team for 10 years. We've been together, and and Joseph's really good about getting the reports and going through them and then saying, you know, hey Jay, I'm noticing some trends here or something different. Um, so we can really kind of target one review from the next so they're not the same. Uh we do a kind of a branch slash borrower lender rotation. Um, so it gives us the opportunity to check some different things, and and he's really good at doing that.

Speaker 01 14:06

Yeah. And and I'm kind of trying to put myself in the seat of the leader of a financial institution. And the first thing that comes to my mind is I want to help my community, right? I I want to help the businesses and the people in my community with their goals and objectives and see them be successful, be part of the successful success story. Uh, but I but I recognize there probably need to be some non-negotiables that I keep in mind. Can you just kind of help educate me on what those non-negotiables should be?

Speaker 02 14:37

Absolutely. And our community banks, uh they're there to service the community. You you you know the guy, you know the individual, you know the lady, you know the organization because you see them every day. But the non-negotiable is credit due diligence. You you can't skip your credit due diligence. You gotta understand what is the question, what does the ask? What are they looking for? Um, you know, we're not gonna just write a check and say go go do well. So you just need to understand that you you have the confidence in in who your sponsor is, your borrower, your guarantor. You gotta understand what your collateral is, you gotta understand have you have you did your environmental due diligence? Did you get an appraisal? Do you understand what the value is? Um, those are just things that you just can't skip. And I and I know in a in a community environment you want to really help and service that individual, but you got to do both of yourself justice and you got to do your due diligence.

Speaker 01 15:27

So it makes sense that I'm starting from the posture of wanting to help, but I just I need to do what I need to need to do.

Speaker 02 15:33

Yeah, I mean we're all there to service our our our clients and whether our clients are banks or their clients or people in the community, um, we all want to help each other, but we just got to make sure that we're doing it within the parameters and it makes sense and then we can lower the risk for everybody. Because you could add additional risk to your to your borrower and and not be inattentional about it, and that's where the due diligence comes in. It it's a two-way streak.

Speaker 01 15:54

That's a really good point, too. And in a lot of ways, this is also in the interest of the borrower. We don't want to put them in a tough spot.

Speaker 02 16:00

I mean, our our our financial institutions are their professional advisors. We're their professional advisors, they advise the community. So they got to make sure that they have the right information and the right people in place to truly service that community. Yeah, yeah.

Speaker 01 16:12

Now, the next thing I think of as you know, the business leader of a bank is I want to grow. You know, I uh anytime you're in business, you want to grow and be successful and not be stagnant. But but I do recognize that this is a regulated environment. So what does growth look like for financial institutions? What do they need to kind of keep in mind and monitor other than just grow, grow, grow?

Speaker 02 16:31

Well, you know, that goes back to those regulatory constraints. So, like I said, it was 100% of capital on acquisition, development, construction, ADC finance, 300% on CRE. Um, just because you hit those buckets doesn't mean you stop. You just they want more granular review. So it in your bucket, if if you know this that you're loaning more construction in a specific industry, you do more multifamily, are you doing more residential or townhomes, whatever the case is, student housing, things like that, they want to make sure that you're not over-leveraged in one particular class because you know you got buckets, then you have classes of loans as well. Um, are you really big into sea stores, gas stations, hotels, motels, um liquor stores, things of that nature? They just want to make sure that if you have a niche, which is great, you're servicing that niche, but do you have the controls in place that you're not too over-leveraged in one specific industry?

Speaker 01 17:20

Gotcha. So just like those core concepts that we encounter often in business, like diversification and avoiding concentrations, just really thinking about it from those common business themes, but but having maybe some more guidelines than other businesses are used to. And it sounds like we don't necessarily have to manage real strict to those guidelines. We just need to keep them in mind and be aware when we're pushing or crossing the thresholds.

Speaker 02 17:44

Yeah, and I promise you, if you get too far over your skis per se, the regulator is gonna pull you back. Um and that's that's what they want. They just want to make sure that you're within compliance of what you're supposed to be. And those guidances have been out since 2006. So they're they're kind of set in stone at this point. But if you're gonna go over them, you you better make sure that you've added it and that you have documentation to support that decision.

unknown 18:04

Gotcha.

Speaker 01 18:05

And and and that kind of brings me just thinking about like warning signs. Like obviously getting close to one of those and maybe crossing over is a potential warning sign, perhaps, you know. But what are other warning signs I can look at as a leader of a fine institution? Or even just when I'm when I'm kind of taking a look at my loan portfolio and thinking about my relationships, you know, when I might have a warning sign with one of my customers and clients who I need to start reaching out to. What are what are things we can do from like a just managing warning signs and monitoring those?

Speaker 02 18:32

If you're one of my clients, you're probably sick of hearing me say it is side inspection, side inspection, side inspection. Go go see your product, go see what you're doing. Um, if you've got a bar that's doing a lot of construction, how are you managing the construction draw process? Have you physically okay? If you say you're 78% funded, did you go physically see that there's a roof, that there's a chimney, a you know, a sidewalk? I mean, have you looked at these things? Um you you have to control the process. You whether it's you're hiring a third party to do it in the construction inspection side, and same thing on the CRE. Go go if you're gonna lend in a community, go to that community. You you can't lend in a community that you don't go visit. Um then on the SBA side, it's it's it's a very servicing intensive industry. Um so a lot of those individual institutions, they'll hire what's called a loan service provider, LSPs. And there's some really good ones in the country, and they'll they'll help them kind of manage that portfolio because it is even more servicing intensive than, say, some of the other classes. So some trust but verify.

Speaker 01 19:31

Absolutely. Now, now when it comes to uh just kind of monitoring, you know, for warning signs and looking for indicators, how how often should I be doing that?

Speaker 02 19:40

Well, at a minimum on an annual basis. You know, that's where the annual review process comes in. And and we've, you know, you gotta based on each institution, it's gonna be different. So, you know, if you're a $250 million institution, you may want to say, hey, any relationship a million dollars and above, we're gonna go visit. We're gonna go talk to them. Um but if you're a three billion dollar institution, you're really Profile may say, you know what, 2.5 or 5 million. It just really depends on your market, but they they need to put that in place. But the annual review process is the hard check and balance. You can't skip that process.

Speaker 01 20:12

So I'm not necessarily just waiting for like a renewal to hit.

Speaker 02 20:15

Well, no. And you know, sometimes you know, we'll they'll treat a renewal event as an annual review, which is acceptable. Um, you know, if you had a uh, you know, sometimes these borrowers have five, six, ten, twelve, fifteen loans. Any, you know, if you're touching that client on a regular basis, you know, that can count as your annual review because you you should have an updated approval, an updated uh credit memo that went through some level of approval authority. And so we do accept those, but you know, at least on an annual basis, something needs to be happening with that with that borrower.

Speaker 01 20:42

So so we talked a little bit about you know just like warning signs we can keep an eye on. Um but I've been also thinking on the front end too, when it comes to me, you know, navigating whether or not it is a good idea for both me and my customer to issue a loan, uh how do I kind of think about what a realistic budget is for them versus just you know wishful big thinking?

Speaker 02 21:04

Yeah, projections and budget are very important. So when you're when you're looking at a transaction, the equity. Everybody wants to talk about equity, debt and equity, they kind of go hand in hand. So if if you've got to put 20% down on some real estate or you gotta do a construction loan that requires 25% or whatever the case is, you want to make sure that you have budgeted cost overruns. That's the number one thing that most people miss is the cost overruns, especially this day and age when we're talking about tariffs. Tariffs can change how much two by four costs by tomorrow. Um, there's a lot of things that can affect your project from the day that you approved it to when you get to that part of the funding stage. So the question is, does your borrower or sponsor do they have the cash or the liquidity to help fund that overrun? Um, there's gonna be overruns. There's always gonna be contingency. So that's when the lender and the borrower have to sit down and say, either we got to come up with some more equity or we have to be okay with adding some more debt. Um it's gotta come from one or two. So you you you can't get 60% into a project, just quit because then nobody wins. So you got to at least get the project finished. So the question is, you know, who's gonna give what? Somebody's got to give somewhere.

Speaker 01 22:10

That makes sense. If the project's going to need capital, how much capital do they already have and are they asking for? And when overruns do happen, where will the excess come from? Existing resources, maybe a capital call to the owner group, or we issue them some more.

Speaker 02 22:25

Yeah, and you know, and it happens. You know, we see policy exceptions. They're documented, you have to provide those to the regulars as well. So we we approved the loan at 80%, the borrower went out of cash, but we've got to finish the project, and we're at 90% now. It happens. It's an exception. We just got to report it, understand that what happened, and then move on from there.

Speaker 01 22:43

Perfect. Now, now I am curious. A couple times in our conversation, we've talked about some like government-backed opportunities. So will you just help me, you know, double-click on that a little bit? You know, what is out there from the perspective of just government-backed loans, government-backed lending that I can kind of think about for our institution, whether that makes sense.

Speaker 02 23:02

Well, and you know, it's not just our institutions, but as far as you know, some of our clients we have within the firm. Um, you know, so there's there's USDA and there's FSA that help uh a lot of the agricultural needs in the communities that are different programs that can go all the way down to the the farm level to you know, just think about the orange juice manufacturer, whatever the case is from that standpoint. Then you have USDA, which is a lot of the job creation. So this is your manufacturing, your equipment, your big capital expenditures. Um the the financial institution is going to fund 50% of that project. The USA puts in a USDA puts in a 40% debenture, um, which is a second mortgage, so it's not a guaranteed loan, it's a second mortgage. And then the borrower has to put in 10 to 15% equity. They're kind of increasing the equity requirements right now, but the minimum is 10%. And then you have your 7A, which is, you know, up to 5 million, which you're talking about, increasing a little bit into some specific job creation categories. But typically 7A loans, you can get a 75-80% guarantee. Um, your loans protected. Some of them are up to 90%, and that goes all the way down to express loans for $350,000 for some smaller type uh borrowers as well. So there's a lot of opportunities to put access to capital and credits that may have a little bit of strain. Talk about that community involvement thing. You know, you want to you want to open up that that new chiropractic office in a community. Well, he this is a loan that will help him, the kid straight out of college, just got his doctorate, and he wants to open up a practice. These are some of those programs that really help with those.

Speaker 01 24:33

Yeah, so it it does. It gives us more opportunities to help customers and clients who we otherwise may not have been able to.

Speaker 02 24:40

Absolutely. I mean, as a banker, the last thing you want to hear is you sit down with your with a potential barber and says, uh, I have little, little cash, uh, a little bit of experience, but I but I have a great dream and I have a new degree and I want to do something. You know, you want to help them, but you're like, well, you know, go go somewhere else. I'm not I'm not gonna do that. This makes sure that we can help those individuals.

Speaker 01 24:58

Well, do some of my best practices need to stand, or because he's a government back, can I rack racket up the aggressiveness a little bit?

Speaker 02 25:04

Uh you know, we we have seen that. Uh we don't like to see that. Uh the answer is no, you shouldn't. Uh these are still they're government guaranteed loans, and if you're not servicing them and there's high risk, I promise you Oakram, which is the Office of Credit Risk Management, uh, they have flags. They have what's called a Paris score, and and when that score starts to increase, you're probably gonna get a phone call, and you might even get called to Washington, D.C. to talk about what that risk went up. So there's there's definitely a uh a non-negotiable. You gotta manage that portfolio because I promise you you won't be have the opportunity to continue that that type of lending very long. I promise you that.

Speaker 01 25:40

All right, I want to get into some just trends that you're identifying and kind of the first thing, are there any kind of hot button regulatory issues you've been navigating now?

Speaker 02 25:48

Yeah, we we've seen an increase in uh call code reporting. Uh we've had a couple of instances uh with a couple of clients actually where the regulars have kind of picked on how they're reporting. One of the biggest common ones is is in ADC, the acquisition development construction. Um, when it's a construction loan, it has one call code that you use. But once it goes to permanent financing, you're supposed to change that call code. Well, additionally, you you can change it to owner-occupied or non-occupied. So that's where your CRE buckets come in. So you can literally have one loan that's in this bucket this month, and then the next quarter it's in a different bucket. And we're seeing some um not very good monitoring when those happen. So you'll do what's called a construction perm loan. The loan will automatically convert to permanent financing. Well, that's the system-generated loan document, part of the covenants thing we talked about. The transfer and the call code reporting sometimes is a manual thing in the operations department that's not always getting called. So we've added some safeguards and some triggers to help kind of pick up some of those. And we've even done some targeted reviews specifically for the call code area.

Speaker 01 26:50

Because that's earlier we were talking about different buckets of loans, loan types, loan classes, and so call codes are how we're capturing them in the right buckets. Absolutely. And then just kind of as different interpretations or best practices shift, we need to make sure we're keeping up with the right codes for the right types of loans. Then also, like you were saying, a loan can change over its life.

Speaker 02 27:09

Right. Yeah. You know, things evolved and like ownership, you know, the building may have started out owner-occupied, yeah. But then the owner decided to move to a new facility and lease out the old one. That bucket just changed.

Speaker 01 27:21

Now staying on trends for for a minute. You know, it just seemed like MA has kind of increased in the financial institution space. Kind of talk me through that. What's something for me as a leader of a financial institution I should kind of keep in mind from an MA space, especially if I'm looking into either buying or selling or joining forces with another institution?

Speaker 02 27:39

We we've had a lot of that at the end of the fourth quarter, um, all the way through really mid-2025. Um, we've had a lot of acquisitions come up. And so it I think there was a lot of uh pinup demand waiting to happen. They want to kind of see what kind of policy shifts happened. But one of the things you know is the due diligence side. We talked about pools and buckets. Um, each institution has a different culture appetite as far as the composition of their portfolio. So you you gotta identify what your pools are, you gotta identify what your buckets are. Then you can kind of run some models and decide where is your pain points. I want a little more due diligence in this bucket. They're they're really heavy in this type of lending. And so it'll kind of help you go through and identify what kind of due diligence parameters you need to talk about. Um, one of the other things that we look at is, you know, we look at their watch reports. We want to know who's on it, watch or worse. We're gonna pick those loans first. We're gonna look if the if the loan were to continue to deteriorate, is there a potential loss? What happens if it, you know, if it does wind up going into a foreclosure situation or litigation situation? We're not gonna tell you what that loss is. We're just telling you there's an opportunity here for you to identify what that loss is. And so those are just some of the buckets that that really, really are important on the front end.

Speaker 01 28:54

Now, what about like post-transaction? Kind of thing, you know, like the the 90 days after I buy or sell?

Speaker 02 28:59

What were the things I should be keeping in mind? Well, the post-transaction is you have a lot of management turnover. You know, so when you're acquiring a portfolio, you you have lenders leave, you have executive change of executive management, some of there's a blending or hybrid of a marrying of the institutions, if you will, roles and responsibilities change. This is when the portfolio typically kind of gets less looked at. We all send in all the reports, we're all asking for information, but it are you managing it at the loan level. Um, so some of that identification, you you've got to be self-aware of what they are, and this is where those client check-ins are very important. So if you're gonna have some lender turnover or you're potentially gonna you know lay off some staff or whatever the case is, you just need to make sure that you you've got out and you got to meet with those borrowers because that you can't beat it at the relationship level. You're gonna have losses, you're gonna have mistakes, things happen. The due diligence process up front is what helps you know minimize those.

Speaker 01 29:54

Yeah, so have that diligence up front. Think about things we think about, and then also just kind of keep an eye on those considerations afterwards to ensure it's all smooth. Well, well, Jay, I had so much fun this conversation. I really appreciate you joining me on the microphone to help talk through these considerations for me. And to our listeners, thank you so much for tuning in. If you have any follow up questions about the financial challenges we discussed in today's episode or any other financial challenges you're navigating, please do not hesitate to contact us at www.mjcpa.com.