We Need to Take Our Medicine
All of us can think of things we know are good for us, but don’t like them. As a child it was getting vaccination shots for what seemed like an untold number of illnesses. As an adult (well) over 50 years old, it tends to be more invasive procedures that are preceded with 24 hours of unpleasant “cleansing.”
The same is often said about credit departments in financial institutions involved in commercial lending. Special focus is reserved for the chief credit officer; that humorless tyrant who never saw a loan deal that he/she liked! You just prayed that the dominant personality and approach was not shared with the rest of the credit personnel.
If nobody really likes the credit department, why bother having them? The primary purpose of having a credit administration department is simple: to identify and mitigate risk. These risks may be “external” in terms of credit review and approval. They may also include “internal” issues such as industry concentration risk in the portfolio, proper documentation and booking of loan relationships in accordance with the loan approval, and effective ongoing monitoring of the customer loan relationship.
This blog will focus on different theories for structure of the underwriting function. Future editions will touch on other topics including ongoing relationship monitoring and documentation.
In the past, I have experienced a couple of different organizational approaches to the underwriting function. However, regardless of structure, the primary requirement of the credit function was independence. As Judy Collins famously sang, “I’ve looked at clouds from both sides now,” which may characterize the lending department and credit department approach to underwriting. This does not mean that an institution should have an adversarial relationship between the credit and marketing (lending) function, but it would suggest that there is a certain healthy tension.
While nearly all financial institutions have documentation, monitoring, and audit functions under the credit administration umbrella, it is not universal that credit underwriting be within the credit department. Some institutions have the underwriting function attached to the marketing/line lenders for management. Under this arrangement there is still a need to maintain a separate (and strong) credit approval officer. Routine credit functions such as statement spreading, borrowing base reports, and appraisal/evaluation review would be housed under credit administration.
This structure is most typically found in organizations that employ a “hunter/skinner” model where the originating loan officer (hunter) effectively hands-off day-to-day management to the underwriter (skinner) after the initial closing. This approach is generally found in large banking organizations and asset-based lending (ABL) firms. Some of the advantages of this approach include:
- It can provide more flexibility in managing underwriting resources
- More points of contact with the client (ideally resulting in a “stickier” relationship)
- more potential career opportunities for underwriters
- Quicker response time to customer requests or questions as the underwriter spends most of their time in the office allowing lenders more time for calling.
The most obvious negative is potential lack of independence in the underwriting function and pressure from the banker/lender on the underwriter. This arrangement also places significantly more responsibility on the credit approval officer.
The more frequent credit department structure is a separate credit analysis/underwriting function reporting to and managed by the credit officer. Because the underwriting function reports to the credit officer, there is (presumably) more independence. One negative, however, is these positions are generally held by younger, less experienced and less trained staff. Also, compared with the lending function, there is generally less career opportunity resulting in higher turnover which can negatively impact credit culture. While this approach gives the credit officer more control over the underwriting process, it comes with the cost of more responsibility for staff training and managing turnover. In some institutions, given the relative inequity in seasoning of the lender vs underwriter, there can be intentional or unintentional “bullying” of the credit partner.
Whatever the approach or credit structure employed by the financial institution, there are a couple of key elements that must exist. First, regardless of position in the credit department or the marketing/lending function, both parties must respect the other as a full and equal partner in achieving the financial goals of the organization. Second is the need for clear credit policy and procedures that are understood and embraced by everyone associated with the lending function. Management of both the credit and lending function will have the most profound impact when all parties jointly apply sound credit principles to every credit relationship.
The lesson? All partners need to act like adults and get your required annual “physical” and take your medicine. You will have a healthier portfolio and credit culture.
Richard Rudolph is Senior Consultant at Enlighten Financial, 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 Rick directly, please call: 920.264.9150.