Advice General

Blocking and Tackling

Posted on June 7, 2016 Published by

As with the sports and meteorological seasons, banking cycles are apt to change and echo themselves. Just when they almost forgotten, the Denver Broncos and Peyton Manning found a way to make themselves relevant again in 2015 with the Broncos first Super Bowl win since 1999. In 1996, the Comptroller of the Currency raised concerns regarding a trend of easing commercial underwriting standards. The concern was that changes in loan underwriting standards may have unintended effects on the risk parameters of loan portfolios that may be amplified with changes in the economy. We are again hearing similar concerns from the regulatory agencies today regarding the easing of credit standards in the headwinds of fierce competition for a limited supply of deals.

The OCC issued Advisory Letter 97-3 (AL) in 1997 to highlight the major elements of an effective portfolio credit risk management process in response to what was perceived as an easing of credit standards. At that time, banks were managing an abundance of liquidity and competition in the market and continued consolidation in the banking industry. Regulators were fearful bank management was moving away from the discipline of a long-term strategic portfolio approach to satisfy the pressure for growth and earnings. Sound familiar?

As such, the nine points issued by the OCC in 1997 (also included as Appendix C, Loan Portfolio Management; Loan Portfolio Management, Comptroller’s Handbook, April 1998) are again receiving attention and remain critical to sound banking fundamentals. The nine points are really the basics for institutions to purposefully incorporate into the culture and methodology of their organizations to develop effective and meaningful loan portfolio management tools. The sports phrase “blocking and tackling” comes to mind. When a football team can effectively execute the basics of blocking and tackling, the team has the ability to move on to the next level. Without mastering the basics of blocking and tackling, it’s unlikely the team will ever be very successful and may not be able to achieve the vision of a championship season or, even better, creating a dynasty.

Football players practice the fundamentals on almost a daily basis during the season. Coaches evaluate athletes and their individual skills and their ability to execute as a team. When not in season, the athletes continue with speed and strength training to improve for the next season. Coaches take time in the off-season to evaluate, reflect, and identify areas that need improvement. It is a constantly evolving process in pursuit of excellence.

These nine points issued by the OCC can be considered the basics of blocking and tackling for a financial institution as they are essential to developing and maintaining a successful long-term strategic disciplined approach. Loan portfolio management requires the same discipline to master the basics of blocking and tackling and facilitate the requirements of achieving organizational and operational success.

The AL included these nine points:

  • Assessment of the credit culture
  • Portfolio objectives and risk tolerance limits
  • Management information systems
  • Portfolio segmentation and risk diversification objectives
  • Analysis of loans originated by other lenders
  • Aggregate policy and underwriting exception systems
  • Stress testing portfolios
  • Independent and effective control functions
  • Analysis of portfolio risk/reward tradeoffs

According to page 3 in The Loan Portfolio Management, Comptroller’s Handbook (April 1998): “Each of these elements is important to effective portfolio management. To a greater or lesser degree, each indicates the importance of the interrelationships among loans with the portfolio. Their focus is not on individual transactions, but on a group of similar transactions and on verifying the integrity of the process. Each practice, by itself, adds a dimension to loan portfolio management, but their value is amplified when they are used together; moreover, the absence of any one of these elements will diminish the effectiveness of others.”

Consider each of the individual players on a football team. The team will perform at a higher level when the players share a common vision and can execute on the basic blocking and tackling. Likewise, the financial institution should view these nine elements as a team. Should any one of the elements not execute the basic blocking and tackling well, it will impede the other elements from achieving and delivering on their full potential.

The OCC views a review of the loan portfolio management process as a primary supervisory activity. The examination process includes procedures to evaluate the steps management has taken to identify and control risk throughout the credit process. The FDIC indicates, “Evaluation of a bank’s lending policies, credit administration, and the quality of the loan portfolio is among the most important aspects of the examination process.” Essentially the examiners want to clearly understand what practices management has in place to identify issues before they become problems.

It’s game time. How well does your team execute on blocking and tackling?

The details of each of the nine elements can be readily obtained for further clarification and study at: http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/lpm.pdf

Enlighten Financial, llc
www.enlightenfinancial.com

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— Meghann Kasper, Chief Credit Officer, Bank First
“Enlighten gives us a very good second set of eyes on our transactions. They're not afraid to challenge us on some of the work that we've done, which is what is needed. I don't need to pay somebody to tell me I'm good, I need to pay somebody to tell me where I've made mistakes.”
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— Bill Beardsley, President, Michigan Business Connection
“By questioning some of our methodologies, Enlighten has helped us say, ‘Okay, this is where we need to train staff better and focus on so that they understand what they're doing better.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“The organization of the communication — before, during, and after the reporting process — was certainly better with Enlighten than what I've experienced with a lot of auditors.”
— Bill Beardsley, President, Michigan Business Connection
“The staff at Enlighten have been available for questions, in addition to the engaged work that they do. They've been very helpful as a resource beyond the major audit.”
— Meghann Kasper, Chief Credit Officer, Bank First
“Enlighten gives us a very good second set of eyes on our transactions. They're not afraid to challenge us on some of the work that we've done, which is what is needed. I don't need to pay somebody to tell me I'm good, I need to pay somebody to tell me where I've made mistakes.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“Enlighten provided industry best practices that weren’t going to show up in an audit report. They would say, ‘Hey, I noticed you do this. This is really unique, you do a really great job of it.’ And then they might add, ‘Some other clients that I have are doing something like this.’”
— Bill Beardsley, President, Michigan Business Connection
“By questioning some of our methodologies, Enlighten has helped us say, ‘Okay, this is where we need to train staff better and focus on so that they understand what they're doing better.”
— Robert McPherson, VP of Risk Management, Peoples State Bank
“The organization of the communication — before, during, and after the reporting process — was certainly better with Enlighten than what I've experienced with a lot of auditors."
— Bill Beardsley, President, Michigan Business Connection