Having been in banking in some form for 30+ years, I have been witness to some incredible cycles and bubbles. Because these cycles and bubbles form naturally in an economy over time, the ability to manage risk, and specifically credit risk, during all phases of an economic cycle and prior to a bubble popping, is vitally important to the health and profitability of your financial institution. I have quickly jotted down my own personal highlight reel of various economic cycles and bubbles in that time.
- 1980 – New York Prime peaked at 21%. NY Prime is currently 3.25%.
- 1981 – Banks were offering $10,000 money market CD’s at 16%. Today $10,000 in a money market or CD earns well under 1.00%.
- 1981 – 30 Year Fixed Rate Mortgage peaked at 18.45%. The low in 2012 was 3.41% and currently is just over 4%.
- 1983 – Agricultural economic recession and devaluation. Ag loan charge-offs in the bank I worked for nearly eliminated the bank’s capital. Owners recapitalized and we survived, but this was my personal initiation into problem loan workouts.
- 2000 – Tech and Stock Market bubble popped. Prior to this, Warren Buffet-style of investing was deemed out of style and out of touch. Dot com companies with little to no revenues were commanding large market caps and increasing $10 share or more every day. Day trading online with trading sites at the time like Datek and such made it easy for everyone to participate, and the market was rewarding everyone without much effort.
- 2008 – “The Great Recession.” This was as close to full global economic collapse as we will ever want to see again. The credit markets froze up for a period of time sending the stock market spiraling downward along with commercial and residential real estate values. Prior to this credit market collapse and great recession period, stated income home loans became the norm and everyone could own a home regardless of income and credit with the growing subprime mortgage financing. While extremely complex, it appears to have been the result of supposedly very smart people on Wall Street, who used sophisticated algorithms to securitize these subprime loans and issue credit default swaps.
- 2008 to the Present – Government bailouts for car makers and banks followed by Fed injection of liquidity into the financial system and decreasing interest rates to historic lows to help stabilize and start the slow recovery out of the great recession.
I likely missed a few other cycles and economic events worth mentioning, but these are the ones that stand out for me personally over the last 30+ years.
It was unfathomable in the early 80’s and the interest rates at that time that we would ever see interest rates this low.
It was hard to imagine for me, that in the mid 80’s, while I was foreclosing and selling Kansas farms at rock bottom prices, to see farm real estate at the current high prices that farm real estate is commanding.
What’s in the future that at the present moments seems unthinkable? A second farm real estate bubble forming? Runaway inflation and higher interest rates to contain? Is it a matter of “When” not “If’? I don’t know and likely no one else likely does. But my intuition tells me that this is the time while the economy is relatively stable to review your underwriting standards and policies by considering the following:
- Require more collateral or lower loan to value standards (particularly on farm real estate).
- Implement loan to value and debt service requirements in your insitution’s policies that are clearly outlined by collateral and types of loans.
- Utilize loan covenants in your loan agreement documents.
Conduct stress tests on term real estate deals to ensure they will cash flow in a rising rate environment as rates re-price.
In conclusion, this exercise in looking at past economic events and cycles is to point out that economic conditions can occur over time that might have seemed unthinkable or impossible. But they did and likely will again. Just be prepared and protect your downside risk or exposure on each credit opportunity that comes along or is already on your books.