What’s In Your Loan Review?
WHAT’S IN YOUR LOAN REVIEW?
Whether you’re a small community bank or a large regional bank, you should have a credit risk review function to analyze individual loan quality and to provide analysis of your entire portfolio quality. On October 17, 2019, the regulators published “Interagency Guidance on Credit Risk Review Systems.” https://www.federalregister.gov/documents/2019/10/17/2019-22656/interagency-guidance-on-credit-risk-review-systems This subject was last formally discussed in 2006, just prior to the mortgage meltdown. Could this guidance be a gentle precursor of things to come?
So, for what are regulators concerned?
First and foremost – Some type of review system. For small institutions, this could be performed by internal staff who are independent of loan origination. For larger institutions, it is often outsourced, providing for more independence. Or it could some form of blended analysis using both internal & external personnel.
But whatever your resource, your program should include the following characteristics:
- Identification of individual loans with potential credit weaknesses.
- A process to validate or revise loan risk ratings, especially given credit weaknesses.
- Identification of portfolio trends and potential problem areas.
- Review of credit policy quality and adequacy and the effectiveness of loan administration.
- Reporting to Management and Board with sufficient time to make program adjustments. It’s not just enough to identify issues but to develop workout plans and to constrict program administration where necessary.
- A process to Inform financial and regulatory reporting (Allowance for Loan and Lease Losses).
Who’s qualified to conduct reviews?
Again, it depends on the complexity of the institution and the nature of your lending program. The guidance recommends: “An independent assessment of risk is achieved when personnel who perform the loan review do not have control over the loan and are not part of or influenced by individuals associated with the loan approval process.” This person should be familiar with bank lending practices, knowledgeable in sound lending principles and compliance regulations, and have experience with any particular risk associated with the bank’s portfolio. No matter how the review is performed, the Board retains overall responsibility.
What should be considered in performing credit review?
According to the guidance: “An appropriate review scope also helps ensure that the sample of loans selected for review is representative of the portfolio as a whole and provides reasonable assurance that any credit quality deterioration or unfavorable trends are identified.” For individual file review, this includes compliance with internal policies, reasonableness of information used in underwriting and approval, abiding by the loan agreement, timely identification of loan deterioration, and so on. The reviewer must also consider external factors – market conditions, economic factors, and industry standards and trends. Of particular concern are risk-based portfolio concentrations, such as with commercial loans where repayment ability and collateral values can deteriorate quickly.
We recommend that every institution review the proposed guidance and adjust their credit review processes accordingly…before your next exam!
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