In an interview earlier this year with the ICBA, Joseph Otting of the OCC warned bankers of the need to remain vigilant regarding the risks accumulating within their loan portfolios. He went on to say that bankers should monitor the quality of new loans, the potential for lender complacency and risks from eased underwriting.
I think that is good advice. Since the great recession and economic collapse of 2008, the U.S. economy has been on an upward trajectory for over the last decade. In that span of time I have personally observed from my position in my bank consulting activities, a gradual weakening of underwriting requirements and loan policies combined with weakening credit and loan administration procedures and oversight. It is understandable that as good times continue for extended lengths of time, to reach for deals by easing on credit underwriting requirements and to eliminate costly oversight in the process. Internal/External loan review penetration levels are being cut annually as asset quality continues to be strong.
The economy has always cycled up and down and will return to recessionary times or worse someday likely in our lifetimes. We just don’t know when – next year or another 10 years from now? When it does return to recessionary times, it helps to be prepared much like you do annually as you assess your various disaster and business continuity plans. The following is my personal 5-point checklist that I recommend every Sr. Loan or Chief Credit Officer review and document to evaluate the overall organization readiness for the next economic recession.
5 Point Lending Checklist – Annual Executive Review
1. Credit Culture
Evaluate your organizational overall ‘Credit Culture’. It starts with executive leadership and their attitudes conveyed regarding credit standards and policies. A lax credit culture could spell trouble for asset quality and ultimately loan charge offs in an economic recession. This is a tough one for executive management to conduct self-assessments. I recommend a trusted third party to evaluate and report in an objective manner.
2. Loan Policy Review
Evaluate the loan policy requirements and changes under a lens over time. Has it become less restrictive over time or have standards and requirements been held in check to minimize credit risk? Are the standards being kept in place and in return and extra larger volume to policy TE’s being approved by the credit committee?
3. Loan Portfolio Management
Evaluate your organizations effectiveness in identifying and monitoring credit risk and setting credit risk rating levels appropriately and consistently. Properly manage documentation and credit exceptions in a timely manner. Gaps in loan documentation prevent enforcement of terms or quick identification of changing credit risk within a business credit. Identify concentrations of credit risk at the industry and borrower level. High concentrations to any one borrower or industry could increase the potential of credit loss. Identify it, report it, and mitigate the concentration identified if possible. Review and evaluate the collections and workout policies and procedures. Effective past due and problem credit management policies and procedures which will become a priority in a recession to minimize credit losses.
4. Credit Management Systems
Evaluate your organizations credit management systems in place. An effective credit management system should be able to quickly and efficiently assist your organizations lending staff and operations in its ability to underwrite and identify credit risk consistently, track and assist in collection of loan and financial documentation exceptions, and provide effective and timely past due collection and problem loan administration and reporting. In good economic times, organizations will tend to ride along with inefficient or fractured systems or no systems at all. In downturns, the organization is spending so much time dealing with a problem loan portfolio that they have neither the time nor the money to implement a credit management system. The morale to this is to invest, implement, and address the need for credit management systems during the good times as there will be no time to do so when you are in the pit fighting alligators every day.
5. Lending Staff Expertise
The final item on my checklist is to evaluate your lending staff experience and expertise. Is it a youthful staff that has never experienced an economic downturn and experienced credit losses? Is it a more experienced lending staff with years of experience in good times and bad but possibly stuck in their ways, not willing to change or learn new technology and better ways of getting things done? It is likely a mix of the two. Identifying and understanding your lending staff’s overall experience and expertise will be useful in crafting ongoing internal or external training leading to a stronger lending staff better equipped to deal with credit problems if they emerge.
Suntell CEO and Founder
Makers of the Square 1 Credit Suite