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Risk Management Practices

Rip Van Winkle, Marijuana and Risk Management Practices

By: James A Swanson, CEO, Bank Strategies LLC

February 2014

Some of headlines I’ve seen over the past week have me contemplating what a 21st century Rip Van Winkle might be thinking after waking up from a 20 year slumber.  Twenty years ago here in Colorado, greyhound racing drew nearly 1.5 million spectators with total handlings wagered in excess of $150 million.  Today greyhound racing is defunct, and likely on its way to becoming illegal.  On the other hand, 20 years ago possessing marijuana was illegal, but today Mr. Van Winkle can walk into one of more than 100 licensed marijuana dispensaries in the state and legally buy marijuana as part of what some estimate is on its way to becoming a $500 million plus dollar per year industry.  For retail shopping needs, prior to his slumber, Mr. Van Winkle likely visited iconic retailers like Sears and JC Penneys, who today, are both arguably on life support.   Banking though, finds itself, in some respects, in a similar situation as it did roughly 20 years ago – emerging from a rough economic cycle characterized by reduced industry profitability, increased credit losses and institutional failures. 

Admittedly saying banking is in the same situation it was 20 years ago is clearly an oversimplification of reality – case in point, the unique challenges today in dealing with the marijuana industry.  Nevertheless, the marijuana issue really gets back to managing risk which is nothing new to bankers.   On the lending front, an article in last week’s Denver Post shared perspective on how some banks are handling situations where properties they’ve financed or taken as collateral have been found to house marijuana businesses.   Perhaps the credit risk issues associated with marijuana business serve as a reminder to take a step back and ensure aspects of your bank’s overall credit risk management program are up to par. 

On the heels of the Recession, where many banks suffered through significant losses and regulatory criticism for concentrations in construction and development lending, we’ve seen some institutions increase focus over the past few years on CRE 2 categories such as non-owner occupied commercial real estate and multi-family residential lending.  Of course this type of lending, without prudent controls and risk management practices, increases the chances of financing a property that contains a business whose activities pose risk to your bank’s collateral.  In today’s world, this could be a marijuana business or more traditional businesses such as dry cleaners, gas stations, auto repair businesses, or other businesses with activities that could potentially contaminate and devalue your collateral.

As such, it is important that credit risk management policies and procedures adequately address such issues in financing non-owner occupied properties, both at the time of underwriting and periodically throughout the life of the loan.  There is no substitute for periodic site inspections and “managing by walking around.”  As part of your overall risk management assessment in this area, it would also be a good time to ensure that loan documentation used adequately provides the bank with commensurate rights and protections relevant to this type of lending.  

As Mr. Van Winkle can tell you, while some things in life certainly do change, others do not including the cyclical nature of the banking industry and the underlying importance of sound risk management practices.   

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