Time To Grow Up
“Oh, grow up!” I cannot tell you how many times I heard that it was Time To Grow Up as a kid. The reality seemed to be that I was living out the lyrics of a Jimmy Buffet song called “Growing older but not up.” I suppose it is an open question if progress has been made!
But what does knowing that it is Time To Grow Up have to do with commercial credit underwriting? Perhaps everything.
Policies and Procedures
All financial institutions have policies and procedures to guide decision-making for their commercial credit clients. Responsible policies address not only the underwriting and granting of credit, but also the ongoing monitoring of credit risk, renewals and adjustments, and response to changes in borrower performance. In addition, provisions should exist to adjust to ongoing changes in the regulatory environment.
A quality set of commercial credit policies and procedures should be both relevant and current; in other words, these policies and procedures may need to evolve – and potentially grow – in response to the current climate. Because of the broad experience the team at Enlighten Financial enjoys, there are several areas of any existing set of policies and procedures that may need a tune-up.
Regarding relevance, does your lending policy address the unique risks and issues of the industries in the portfolio? A comprehensive loan policy would likely include guidance for the key credit risks associated with such different industries. Contractors, health care, agriculture, commercial real estate (including the specific risk associated with various subsets such as multi-family, retail, office, land development, etc.), and manufacturing. Best practices would suggest that a well-developed risk rating procedure would have a separate risk rating matrix for major segments such as agriculture, CRE, and commercial and industrial (C&I) to address the specific risk elements of each industry.
Does your institution has a risk rating matrix tailored to specific industries? If so, is it providing an output that is accurate? Or are there a significant number of overrides for the credits reviewed? In addition to the number or frequency, how well do you document the reason/rationale for the override? Is there an override of a specific factor in the matrix? For example, if a borrower has a calculated DSC of 2.0, which is the basis for an override, yet DSC is already a factor in the rating matrix, is such an override appropriate or should the weighting in the matrix be adjusted?
Is the risk rating recommended by a matrix routinely subject to override for a particular factor or reason? Perhaps the matrix should be adjusted to include this factor. Finally, as an organization, has an analysis of historical credit losses to assess whether the risk rating matrix is accurately identifying future credit losses been conducted?
The Highlight Of The Pandemic
One of the blessings that may have come out of the past 15 months of “COVID time” is that a spotlight has been shining on whether present policies and procedures are current. Existing policies and procedures need to be reviewed against any new regulatory mandates and/or guidelines. Enlighten Financial’s ability to evaluate whether policies and procedures are relevant is great. We also identify areas that may need to be updated for new regulations and guidelines. Broad experiences with other institutions can also highlight current industry best practices.
A common area of weakness is with regards to appraisals and evaluations. Issues include appraisal and evaluation review with particular focus on how to validate an existing appraisal. How long is an appraisal considered valid? Given the dynamics of the current real estate environment and the complications caused by the pandemic, it is difficult to imagine that the state of the market has not changed in five years. Does the current policy reflect the most current guidance on HVCRE? Are there updates needed for shared national credit policies? Has your institution expanded its geographic footprint in search of new opportunities? Or unknowingly taken on new and potentially higher risks with new industry concentrations? If COVID has taught us anything, it’s that we found it’s Time To Grow Up when reviewing all of our policies and procedures.
Always Set Up Reviews
A robust commercial lending portfolio requires a dynamic set of policies and procedures to guide risk evaluation, monitoring, and response. A policy and procedures manual that was developed and put on a shelf without frequent review and updates to respond to a rapidly evolving economic environment becomes a blind guide. And we know that “if a blind man leads a blind man both fall into a pit” (Matthew 15:14). Wisdom and good advice can be found in old and new sources, so indeed, it’s Time To Grow Up!
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. We lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Rick directly, please call: 920.445.8133.Tags: Enlighten Financial, Time To Grow Up