Loan Review Reporting

This the third in a three-part series on best practices in loan reviews. Part 1 focused on loan review governance; and part 2 looked at scope and depth of loan reviews. 

A loan review can provide critical objective insights into underwriting, credit administration, risk management, policy adherence, personnel, funding of the allowance and other facets of the credit function of the institution. A formal loan review is uniquely positioned as a part of risk management, providing access to the various components of the credit function and their inter-relationships. This position provides for an objective, inter-related view of the credit processes and procedures. A credible reviewer should be able to produce an in-depth report that both effectively communicates the status of the risk ratings along with the critical observations regarding the facets of the credit function.

Reporting is a compilation of the various findings, items, issues, strengths, and other components identified and discussed during the loan review process. It is the documentation the audit committee should rely on to gauge the status of the loan portfolio and the strength of the risk management strategies employed in the credit underwriting and credit administration processes. It is also the document your examiners will request during a safety and soundness exam. Examiners may place significant reliance on the information included in a loan review report; this may depend if the process was conducted by a reputable firm or if the institution has a sound independent loan review process.

An effective and accurate loan review report will include insight gained through discussions with the appropriate credit or loan officers during the review. The report should only include items and information that was discussed during the review or the exit meeting. Items and information not previously discussed with senior credit officers or other relevant management should generally not be included in the report, as the review process is the more relevant channel to include dialogue to address questions or concerns of the reviewer, management, or the review process.

The following are key items that should be included in a loan review report:

• Addressed to the audit committee or designee
• Executive summary to include key findings or observations
• Scope of the review
• Summary of the coverage
• Summary of the procedures performed
• Recommended risk rating changes
• Identification of loans with well-defined weaknesses
• Adherence to the loan policy
• Administrative processes
• Identification of trends in the portfolio
• Other factors impacting the loan portfolio
• Continuous Review Process — should include metrics on coverage, coverage to plan and discussion for any variance from desired pace

We recommend the report be limited to the higher-level findings of the review process. Effectiveness may be diminished should the report become unnecessarily lengthy, so a concise, well-written report can be an effective tool for management to utilize. Detail will be included on an as-needed basis to illustrate examples, and supporting work papers should be maintained if management wishes to gather additional information regarding items in the report. Management may elect to provide the work papers to the loan officers and other relevant parties as standard part of the loan review process.

We encourage a draft report be issued to management at the conclusion of the review. A draft report will allow management the opportunity to review the information and address any questions or clarifying items with the reviewer. It is critical the findings and recommendations in the report be accurate and management have the opportunity to provide additional insight to be considered for the report or recommendations. However, it is also critical the process remain independent and objective without undue influence from management.

The draft report should be the means for management to provide a response to the findings and recommendations included in the report. Examiners expect a management response to the findings to provide a clear understanding of management’s view of the findings and their planned actions as a result. The managerial responses can serve as a reference point for examiners to confirm the responses in the next regulatory review.

A final report will then be issued after incorporating management’s responses into the report. This will then become the document the audit committee of the board of directors should utilize as a part of their fiduciary responsibility to see that the institution is appropriately managed. Management can use the report to make enhancements to the process. The final report should also be shared with the regulatory agencies upon request.

A well-written, concise, and effective loan review report should be a staple of risk management for a financial institution. A sound loan review process should identify items critical to credit underwriting and administrative functions. Trends, risk ratings and other items can be objectively identified to permit management the opportunity to address issues and minimize any further adverse impact. In addition, risk ratings are a significant component of loan review discussions and reporting. Accurate risk ratings are critical to an appropriately funded allowance. The loan review process can provide additional assurance as to the appropriateness of the funding for the allowance for loan and lease losses.

Enlighten Financial is a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape, and lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to us directly, please call: (920) 445-8881.