With an anticipated downturn in construction, now is the perfect time for construction investors to revisit policies and procedures. The increased yield from construction loans can contribute significantly to a bank’s bottom line, but with increased yield comes increased risk. After the Great Recession studies by FDIC and the Office of the Inspector General (OIG) showed that some lending institutions with high construction loan concentrations weathered the recession with no significant decline in overall financial condition. At the same time, though, almost all banks that failed during the recession had significant construction portfolios.
An increase in troubled loans is expected as a result of the pandemic. Lessons from the FDIC and OIG studies could provide useful tips to help mitigate risks. Aggressive growth, high construction loan concentrations, poor risk management practices, ineffective controls and risky decision making were identified as past contributors to the failure of most institutions.
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