|May 24, 2017
Five Ways to Unlock the Full Value of Loan Review
By Ancin Cooley, Principal, Synergy Bank Consulting and Synergy Credit Union Consulting
If you grew up north of the equator, you can probably remember the excitement you felt playing in the freshly fallen snow each winter. As you bounded toward the front door, ready to throw yourself into a fluffy pile of wintertime fun, you were stopped by a parent, ready to burden you with a heavy coat, gloves, scarf and hat. As the layers piled on, you wondered who could possibly have fun in all of this. However, once outdoors, you realized that your protection made the snowy adventure even more enjoyable.
A similar analogy can be drawn about loan review. Attempting to quickly grow your loan portfolio or move into new areas of business without a fully functioning loan review program is like trying to play in the snow without a coat on. You’ll never enjoy the snow if you’re not equipped to withstand the freezing temperatures that will undoubtedly accompany it. Likewise, you’re unlikely to see the sustained growth you seek for your institution if you fail to implement key processes that protect you from the imminent pitfalls associated with growing or integrating a new loan product.
Even the most conservative institutions pin growth and profitability as primary goals. However, in order to maintain healthy growth, institutions must keep a reliable pulse on the performance of their loan portfolio and accompanying credit risk issues. Effective loan review keeps that pulse by consistently monitoring the risk management function. With a strong loan review department to keep things on track, the institution will have the freedom to explore new products and industries with confidence.
If it’s true that loan review is the key to monitoring risk, then where was it during the last major downturn? Amid the slew of potential issues that crippled loan review and lead to the last downturn, these primary issues took precedence, and in many cases their continued presence is still putting institutions in jeopardy:
- Insufficient analysis to support the risk rating
- Failure to document major issues and the answers leading to their conclusion
- Failure to discuss credit administration weaknesses
- Insufficient numbers and experience of staff
- Failure to discuss and address portfolio risks
- Organizational and hierarchical missteps
- Lack of follow-up
Today, commercial real estate levels are back to where they stood pre-downturn. Institutions that have a strong early warning system – built by loan review – are able to identify and remediate problems faster.
Once your institution realizes the full value of the protection offered by a high-functioning loan review team, you may actually look forward to having an independent group of professionals hand you a pair of gloves, fit you with a coat and wrap you tightly in a scarf before sending you off to your next deal. To make sure your institution is getting the full value out of its loan review process, be sure to pay close attention to these five practices:
Craft a Risk Appetite Statement
The risk appetite statement helps your institution determine the direction of its lending program in an effort to grow more intentional portfolios that will bolster its overall health. When crafted as part of your yearly strategic planning process, your institution will be primed to grow portfolios by aligning your goals with your unique risk appetite.
This statement serves as a crucial guide by outlining the institution’s risk appetite, risk capacity and risk profiles, driving your institution’s decision-making over the next year.
While risk appetite refers to the amount of risk your institution is willing to accept in pursuit of loan growth, risk capacity quantifies the maximum risk that the firm is able to withstand. Risk capacity is based on metrics like capital, liquid assets and borrowing capacity, among others. Target risk profile represents the allocation of appetite to risk categories (e.g., how many home equity or car loans you will grant?). Actual profile represents risks that are currently assumed.
When gathering information that will eventually become the risk appetite statement, it’s important to engage with and incorporate the input of parties such as the board, CEO, CFO, lenders and internal auditors.
Align Loan Review with Risk Monitoring
For some institutions, this maxim is already a no-brainer. While past industry-wide practices have placed loan review within the purview of internal audit, forward-thinking institutions are making the shift toward aligning loan review with risk management. In fact, loan review is increasingly being referred to as credit risk review, thus highlighting the shift in thinking about the functionality of loan review.
When loan review is repositioned within the organization’s hierarchy, this seemingly small organizational shift can have a seismic effect on the overall effectiveness of the loan review function. This is achieved through utilization of independent authorities that perform candid, unbiased reviews.
Put simply, a loan reviewer must be able to safely “speak truth to power.” The reporting structure should be organized in a manner that allows for both the formulaic testing and critical, open-ended examination allowed under risk management.
Further, compensation levels are another key component of loan review effectiveness. Because the loan review position is critical to the success or failure of a financial institution, the institution must hold it in esteem for internal controls and for external appearances. By providing loan reviewers a proper place in the hierarchy of the organization, the institution communicates the seriousness and intrinsic value of the loan review position and its responsibilities.
Apply Strategy to Price Monitoring
A “one size fits all” approach just doesn’t work in the land of lending. Building a strategic pricing system through close monitoring of loan administration is critical to maintaining a healthy portfolio.
Even after a borrower has been with you for some time, things like credit worthiness, collateral values, and deposit balances all change over time, requiring a change in strategy on the part of the institution. Utilized fully, your loan review department can help keep an eye on these many changes and help steer the institution toward the best set of solutions.
Hone In on Small, Targeted Reviews
While broad, sweeping reviews are seemingly effective, getting down into the devilish details can expose smaller issues before they become significant problems. Specifically, performing deep dives into your appraisal management, special asset and loan administration function create tangible value and ROI.
Perform Post-Mortems on Large Charge-Offs
There really is no better vision than hindsight. Looking at your largest losses incurred over the last three years will allow you to identify whether there are any core themes that recur throughout. When armed with knowledge about what hasn’t worked, you can mitigate similar losses in the future. This is undoubtedly a best practice.
Before implementing these practices, make sure they are codified in a strong loan review charter or policy that is signed by the board of directors. Memorializing these practices solidifies loan review as a strategic asset, and equips the loan review team to objectively and independently unlock the strategic value of loan review.
Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of the Financial Managers Society.
About the Author
Ancin Cooley, Principal, Synergy Bank Consulting and Synergy Credit Union Consulting
Ancin Cooley is the Principal of Synergy Bank Consulting and Synergy Credit Union Consulting, both of which specialize in loan review and strategic planning. He can be reached at firstname.lastname@example.org