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Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
1
JOIN. ENGAGE. LEAD.
THE RISE AND RISKS OF LENDING
TO NON-DEPOSITORY FINANCIAL
INSTITUTIONS
An Excerpt from “2017 Industry Insights:
Perspectives from the Front Line”
by RMA’s Credit Risk Council
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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Private equity
investments in
financial technology
(fintech) firms
exceeded $10
billion across more
than 500
companies.
2016
Nonbank mortgage
lenders accounted
for more than half of
mortgage loans; 6
of the top 10
mortgage lenders
were nonbanks.
Late 2016
In the wealth
management
sector, digital and
automated robo-
advising is growing
and threatening
traditional business
models.
2016
The OCC’s
semiannual Risk
Perspective, states
that loans to non-
depository institutions
were up 150% in
three years,
becoming the fourth
largest commercial
loan category.
Fall 2016
THE RISE OF NON-DEPOSITORY FINANCIAL INSTITUTIONS
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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CREDIT FACTORS
Bank Credit
A broad array of non-depository
financial institutions use
bank credit:
Includes mortgage, bus. development, finance and leasing
companies, RE investment trusts,
hedge funds, private equity firms, nonbank consumer lenders, and others.
Loan Types
Loan types and structures vary:
Typically, include warehouse lines
of credit, revolving credit facilities, and capital call
lines.
Secured Credit
Credit to these sectors is generally secured:
Frequently, with tightly controlled and monitored
structures.
Borrowing Bases
Borrowing bases are often used:
Tying credit availability to a
maximum percentage of the
assets being financed.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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IMPACT
There is an increasing
importance of nonbanks to all
facets of the financial services
industry, including the
competitive threats they present
to traditional banks.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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IMPACT (CONT.)
While many of these nonbank
sectors provide investing,
partnership, and financing
opportunities for traditional banks,
they also create numerous risks,
including credit risk.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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JOIN. ENGAGE. LEAD.
Lending to non-depository
financial institution comes with
credit risks that can be
substantial and can arise from
various factors.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
ASSET EVALUATION
Failing to properly evaluate asset quality in the borrower’s
portfolio poses risk.
• Example: lending to a finance or business development
company with heavy exposure to highly leveraged
businesses.
• Example: Financing a real estate investment or
mortgage firm with excessive geographic
concentrations in declining markets.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
AGGRESSIVE UNDERWRITING
Underwriting aggressively and
outside of industry norms can be
problematic.
• Example: using advance rates
that exceed generally accepted
levels or financing asset types that
other banks normally exclude.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
ASSESSING THE BORROWER
Financing borrowers with very high leverage and little
absolute capital, because you are comfortable with their
track record and cash flow stability can be risky.
• It’s critical to understand the ability of such borrowers to
operate under stressed conditions.
Using looser credit structures for borrowers who appear to
be well capitalized when their underlying portfolios are
highly risky and subject to large losses can cause
repayment problems.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
ASSESSING OPERATIONAL CONTROLS
You should properly assess the
operational controls of
borrowers and their ability to
manage complex portfolios and
business models.
• How good is the borrower’s own
credit reporting and how well
does it monitor its clients?
• Does the borrower track and
share early warning indicators?
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
ASSESSING THE INVESTORS
You must properly assess the quality
and quantity of investors when
providing capital call facilities backed
by committed capital.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
UNDERSTANDING THE BORROWER
You should understand the
borrower’s own credit policies,
underwriting standards, and
exception trends.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
COLLATERAL VALUES
In secured facilities,
overestimating collateral values
and not adjusting advance rates to
market conditions is risky.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
CONCENTRATION RISK
You must recognize and/or
structure around significant
concentration risk in the
borrower’s business, which could
be any combination of single
obligor, sector, geographic, or
asset type.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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THE RISK:
REPUTATION RISK
If the borrower is financing risky clients, this
could create reputation risk for the bank
involved, particularly in a workout situation.
It’s important to understand the sectors and
specific clients being financed.
A good rule of thumb is if a bank would not lend
directly to the end borrowers, then it should think
twice about lending to the entity directly.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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CREDIT RISK FACTORS
The list of risk factors outlines some of the principle risks and demonstrates that successful lending to this broad sector requires:
Industry
knowledge
Effective
underwriting
standards.
Significant due
diligence
Ongoing
monitoring.
There are undoubtedly other credit risks not indicated in this presentation.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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CREDIT RISK FACTORS (CONT.)
Consistent with broader trends during
recent years, banks have enjoyed strong
credit quality in these sectors, but that could
change, and understanding these key credit
risks is important to any institution with
exposure to these industries.
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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The Credit Risk Council supports
professionals who are responsible for
establishing, maintaining, or carrying
out credit risk management policies.
The council focuses on funded and
off-balance-sheet risk management,
including capital markets activity, and
other forms of credit intermediation
and risk mitigation.
ABOUT RMA’S CREDIT RISK COUNCIL
Enterprise Risk · Credit Risk · Market Risk · Operational Risk · Regulatory Compliance · Securities Lending
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For additional information about
credit risk management,
visit
www.rmahq.org/credit-risk/
LEARN MORE
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Visit http://www.rmahq.org for information on risk management.
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purpose is to advance sound risk principles in the financial services
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