Increased labor costs and related challenges such as talent acquisition have affected all industries, including banks. Additionally, banks are facing potential deteriorating credit quality, growth challenges amid tightening credit standards and increased scrutiny from regulators and auditors.
Loan origination, portfolio management and credit quality reviews are key areas to successfully managing increasing credit risk. It’s critical that banks understand their risk appetite and credit risk profile prior to making any changes in these areas. You should also discuss any material changes you plan to implement with your regulatory agencies and board, to ensure these changes don’t create undue risks.
Originating new loans doesn’t have to be cumbersome and complex for both the bank and the client. The risk and rewards are a delicate balancing act. And not all loans require the same level of due diligence or documentation.
Banks might want to consider establishing minimum loan documentation requirements and underwriting parameters based on loan amounts. This can put them at a competitive advantage compared to financial institutions requiring more documentation that can increase the loan processing time.
Centralizing the loan origination process for less complex and smaller loan amounts can streamline the workflow, potentially helping with consistency and efficiency and allow less-experienced staff to process loans.
Automation may be useful if your bank has a high volume of loan origination requests. The board should consider conducting, or hiring a consultant to complete, a cost-benefit analysis that could consider automating various aspects of the underwriting process. You may find automation is not only cost effective but might reduce human errors and improve consistency in credit decisions.
Ongoing management of the loan portfolio also doesn’t have to be time consuming. Not all loans are created equal or create equal risk for the bank; ongoing management should correspond to the risk of the loan portfolio. Consider evaluating the frequency of the internal loan reviews based on various risk attributes, including risk ratings, loan amounts and other financial and non-financial factors.
Internal Credit Reviews
An annual internal credit review might be all that’s necessary for loans that have lower risk attributes, such as small-dollar loans, loans secured by readily liquid collateral and loans with strong risk ratings. Banks should instead conduct more-frequent internal reviews on larger loans, loans in higher-risk industries, highly leveraged loans, marginal performing loans and adversely risk rated loans.
When completing frequent reviews, focus on key ratios relevant to the borrower and monitor and identify financial trends. An internal review doesn’t necessarily require the same level of analysis as an annual review or effort performed at loan origination.
Payment performance or bulk risk rating could be an alternative for banks that have a high volume of small-dollar loans. These types of loans are low risk, monitored through frequent reporting that uses payment performance and require minimal oversight.
Finally, centralizing the portfolio management might be appropriate choice for a bank and can create efficiencies, consistencies in evaluation and reduce overhead expenses.
Credit Quality Reviews
From small borrowers to national corporate clients, there are many creative ways that banks can achieve loan coverage in credit quality reviews while retaining the ability to identify systemic risks.
Banks can accomplish this through a risk-based sampling methodology. Rather than selecting a single risk attribute or a random sample within the loan population, you may be able to get the same portfolio coverage and identify risks with the following selection process. Focus on selecting credits that have multiple risk attributes, such as:
- Borrowers with large loan commitments, high line usage, unsecured or high loan-to-value, adversely risk rated and high-risk industries.
- Select credits with a mix of newly originated and existing loans, new underwriters and relationship managers, various loan commitment sizes and property types and collateral.
Consider credits within the Pass range that may have marginal debt service coverage ratios — typically the most common multiple risk attributes for identifying risk rating discrepancies — or are highly leveraged, unsecured or lack guarantor support.
More targeted reviews can offer banks additional portfolio coverage. These types of reviews require less time to complete, giving institutions the ability to also identify systemic trends. Below are some things to consider when selecting a targeted review.
- Select a sample of loans with multiple risk attributes and confirm the risk ratings by reviewing the credit write-up for supporting evidence and analysis.
- Complete a targeted review of issues identified in the previous risk-based sampling reviews.
Finally, for banks that have recently acquired a loan portfolio, review the two banks’ credit policies and procedures and determine where the are differences. Select loans that are outliers or don’t meet the acquirer’s loan risk appetite.