PowerPoint Presentation

LOAN PORTFOLIO MANAGEMENT – YEAR 2

Michael Wear
Senior Credit Analyst
First National Bank of Omaha
Credit Administration
Omaha, Nebraska
&
Owner
39 Acres Corporation
Omaha, Nebraska
mikewear@hotmail.com
402-871-9067

August 5, 2016
LOAN PORTFOLIO
MANAGEMENT:
STRATEGIES &
TOOLS
MICHAEL WEAR
SECTION LEADER: LOAN PORTFOLIO MANAGEMENT
GRADUATE SCHOOL OF BANKING - WISCONSIN
AUGUST, 2016

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CREDIT QUALITY

FDIC: Quarterly Bank Profile 1Q2016

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CREDIT QUALITY

FDIC: Quarterly Bank Profile 1Q2016

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CREDIT QUALITY

FDIC: Quarterly Bank Profile 1Q2015

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CREDIT QUALITY

FDIC: Quarterly Bank Profile 1Q2016

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 CREDIT QUALITY

2015

PayNet: Small Business Credit Outlook 1Q2015

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 CREDIT QUALITY

2016

PayNet: Small Business Credit Outlook 1Q2016

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THESE ARE (CONTINUING)
DIFFICULT TIMES…
“I doubt there’s been a more difficult time for a bank risk
manager in a good many years—certainly not in my lifetime.”
“While reserves remain at a high level industry-wide,
quarterly provisions are smaller than charge-offs.”
• Thomas J. Curry
Comptroller of the Currency
RMA Risk Management Conference
(11/2013)

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ALLL PROVISIONS &
CHARGE-OFFS

FDIC: Quarterly Bank Profile 1Q2016

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ARE WE GETTING LOOSE
(AGAIN)?
“Some of the loans we see banks making today are going to
customers who almost certainly would not have qualified for
the same loan 4 to 5 years ago.”
• Thomas J. Curry
Comptroller of the Currency
RMA Risk Management Conference
(11/2015)

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TROUBLED INDUSTRIES
Historical Volatility: Recent Volatility:
Budget motels Oil & Gas
Trucking
Ag (commodity-based)
Logging
Taxi Services
Golf Courses
Retail Strip & Big Box Retail
Contractors/Developers
Restaurants

Leveraged Buyouts
Ever-present:
ESOP Loans
Leveraged Lending
“Enterprise Value”

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FIRE! ANALOGY

1. Where is the risk of fire? Identify Early

2. What would a fire do to the bank? Expected Loss (EL)
3. How likely is a fire to happen? Probability of Default (PD)
4. Are we doing things to increase the risk of fire?
Re-evaluate: CRM/ERM, Credit Policy (Exceptions), Loan Review
5. What needs to take place to help prevent a fire?
Refine: Risk Culture, Policies/Procedures
6. What do we need to put the fire out?
Capital Planning, Manage Underlying Causes

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A DIFFERENT PERSPECTIVE
Traditional Credit Loan Portfolio
Risk Mgmt. Risk Mgmt.
Scope Product Type One Portfolio
Incentive Loan Volume Economic Profit

Philosophy Originate & Hold Underwrite &

Distribute Risk
Evaluate Transaction, Loan Segments,
Customer Co-variance of
Risk
Pricing By Product Type Risk-based

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LOSS EMERGENCE TIME LINE
Forward-
• Change in Demand
Looking • Economic Cycles
• Decline in Sources of Income

• Loss of Major Customer

Loss Event • Job Losses
• Property Values Decline

• Financial Statement Monitoring

Discovery • Covenant Violation
• Delinquency

Response/
• Risk Rating Criticism
Outcome • Work-out
• Charge-off

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 HOW TO STEP-UP
YOUR BANK’S LPM

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ROOT LPM IN CREDIT
CULTURE

Risk Culture

Policy & Procedures

Loan Portfolio
Management

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TRUE LOAN PORTFOLIO RISK
MANAGEMENT

A profound shift...
From: Managing Credit Risk Upon Discovery
To: Scenario Testing & Capital Planning

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STRENGTHEN YOUR
3 LINES OF DEFENSE
1. Business Unit
• Individual accountability and responsibility for actions and
decisions? Consequences?
• Are bank objectives weighed more than individual or profit
center goals?
• Do we truly take the time to instill our values?

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3 LINES OF DEFENSE
2. Management
• Board governance
• CCO should not be alone to enforce discipline
• A culture of “Everyone is responsible for risk.”
• Establishment of CRO or risk committees (board or
management levels)

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EXAMPLE: A MORE GRANULAR
RISK RATING MATRIX

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3 LINES OF DEFENSE
3. Loan Review
• Models are no substitute for hands-on review
• Traditionally aligned with (external) audit
• Current trend to align with risk management
• Reviewer’s skill sets and experience; outsource benefits
• More proactive with Business Unit:
• Economic & competitive industry drivers
• Loan underwriting (collateral monitoring & covenants)
• Pre-closing (documentation, approval terms)
• Post-closing
• Periodic (annual) reviews

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FILE REVIEW
VS. LOAN REVIEW
File Review
• Compliance with approval terms & credit policy
• Financials, DSCR, LTV

Loan Review (risk identification)

 Cash Flow analysis
 Collateral valuation
 Loan structure & documentation
 Industry trends
 Identify training needs

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LOAN REVIEW
VALUE ADDS
Behavior alignment with credit policy, stated risk appetite
Approving authority structure
• Checks and balances, Incentive plan basis
• Individual lender tendencies
Risk Rating accuracy
Policy & Underwriting Exception management
Loan monitoring commensurate with risk trends
Adequacy of ALLL

On your Student Website: Top 10 Characteristics of a successful

Loan Review function

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EXCEPTION TRACKING
(4 KEY AREAS)

Risk Ratings Policy Exceptions

Technical Underwriting
Exceptions Exceptions

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EXCEPTION TRACKING

Risk Ratings
• Individual loans (material borrower changes vs. bank errors)
• “Double-dips”
• Aggregate Risk Ratings
• By loan segment
• Direction
• Overall accuracy
Technical Exceptions
• Financials not received per approval
• Documentation shortfalls (e.g. missing info, signatures)
• Covenant violation without acknowledgment/waiver

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EXCEPTION
TRACKING
Policy Exceptions
• Compliance with policy & regulations
• Guaranty coverage
• Outside market
• Concentration limit exceeded
• Approval authority

Underwriting Exceptions
• DSCR, DTI guidelines exceeded
• Collateral documentation issues
• Inspections do not meet approval requirements
• Loan term exceeds guideline
• LTV exceeds guideline
• Weak quality or timing of financial information
• Unsecured lending guidelines not met

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CONCENTRATIONS
CAN KILL
Correlated credit exposure
• Borrowers
• Industries (co-variance)
• Supply chain risk (interest rates: developers, homebuilders)
• Common factor risk (fuel cost: trucking, ag production)
• Product Type (first mortgages, HELOC’s)
Community (smaller) banks are inherently less diversified
than large banks
Regulatory Guidance:
• OCC Comptroller’s Handbook: Concentrations of Credit
(2011) [located in Student Website for this course]

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MANAGING
CONCENTRATIONS
Risk Appetite Statement [Policy]
• Board-driven (top-down support)
• Goal: To ensure aggregate risks do not exceed the bank’s
risk capacity (capital base)
• Separate Statement or made part of Credit Policy
• Need to define:
• Geography – primary and secondary market territories
• Industry or sector [first 2-digits of NAICS codes]
• Roles & responsibilities of management, lenders, staff
• Report types & frequency

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MANAGING
CONCENTRATIONS
• Concentration Reporting
•Graphs/Output are NOT the sole focus of managing
concentrations
• Longer-term trends
• Notable recent developments
• Peer comparisons, if available
• Macro-economic Correlation
• Chart loss history of industry/loan type with changes in GDP,
local unemployment, housing starts, or business conditions
surveys, such as:
• Creighton University’s Economic Outlook
(business.creighton.edu/economicoutlook/)
• Aruoba-Diebold-Scotti Business Conditions Index
(philadelphiafed.org)

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MANAGING
CONCENTRATIONS
Setting Concentration Limits
• Loan Type
• Geography
• Borrower (related entities)
• Bank’s house limit (< legal lending limit)

• Exceeding the 100% or 300% CRE thresholds:

• triggers for regulatory scrutiny & robust risk management.

• Approvals required to go over Concentration Limits.

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MANAGING
CONCENTRATIONS
Strategies for:
• Organic Growth
• Address existing concentrations when prospecting
• Discourage additional lending in over-limit areas
• Communicate credit expectations
• Tighten credit quality standards
• Inherent risk in just increasing loan pricing
• Purchased Loan Participations
• Evaluate in-house expertise
• Lead bank’s culture, covenants, and monitoring
• Background checks on borrowers/principals

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STRESS TESTING
• Identify triggers or key variables for potential losses
• Develop Scenarios and Test impact on DSCR & LTV
• Combine data variables for scenarios—some examples:
• C&I = DSCR and LTV
• CRE = Cap Rate and LTV
• Consumer = Credit Bureau Score and LTV
• Assess bank’s vulnerability to downside scenarios, using:
• Market (Economic) Analysis
• Correspondent Bank
• Follow favorite Economists
• American Bankers Association
• External sources of information
• Local/state government, industry trade magazines
• Real estate transactions, taxable sales data
• Google News – Specific Industry info
• Personalize Google News
•

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STRESS TESTING

• Using Stress Testing to Test Capital Adequacy

• Vulnerability x Likelihood = potential Qualitative Factor in
ALLL
• Historical relationship between changes in Non-accruals
and Charge-offs (time lag)
• What happens to ability to make Provisions with step
increases in Non-Accruals?
• Shift in underwriting strategy and expected effect on loan
volume
• Effect of losing major customer relationship(s)

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HOW TO GET THE MOST
OUT OF YOUR LPM*
Avoid These:
• Focusing on outcomes, not causes
• Portfolio quality ratios reflect results of past lending
decisions (possibly 3-5 years ago).
• Mergers & acquisitions’ affect on portfolio mix and
dynamics
• Failure to adapt
• Not growing the portfolio monitoring with the growth of the
bank
• Specialized lending (e.g. residential construction, trucking,
hotel/motel) require different key variables to track.

*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

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HOW TO GET THE MOST
OUT OF YOUR LPM*
Avoid These (continued):
• Present Snapshot only
• Limited focus, lacking perspective (historical comparisons)
• Numbers without Analyzing
• Lots of graphs, tables and data…but no:
• Interpretation of results
• Discussion of trends
• Recommendations

*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

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HOW TO GET THE MOST
OUT OF YOUR LPM*
Minimum LPM Reports:
• Portfolio Composition
• Borrower (related) relationships
• Call Report categories; Industries; Geography; Loan types
• Portfolio Risk
• Risk Ratings
• Large Loans
• Policy Exceptions
• Portfolio Quality
• Delinquencies (new, migration), Non-performing
• DSCR, DTI, LTV, monitoring defaults
*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

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HOW TO GET THE MOST
OUT OF YOUR LPM*
Minimum Types of LPM Reports to include:
• Loan Officer Assessments
• Addresses portfolio management (e.g. past dues,
monitoring exceptions, maturity extensions, etc.)
• Ideally additionally addresses key drivers for incentive
plans (e.g. portfolio profitability, loss rates, etc.)

*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

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MONITORING PORTFOLIO
PERFORMANCE
• Typical LPM Key Metrics:
• Past Dues / Total Loans & Leases

• Non-Performing Loans** / Total Loans & Leases

• Non-Performing Loans / ALLL
• Non-Performing Loans / Capital & Reserves [Tier 1 + ALLL]

• Classified Loans / Total Loans & Leases (+ OREO)

• Classified Loans / Capital & Reserves

• Net Charge-offs / Total Loans & Leases

• ALLL Provisions / Net Charge-offs
**Total loans and leases > 90-days past
due + non-accrual loans and leases +
other real estate owned [OREO]

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 MONITORING PORTFOLIO
PERFORMANCE
Sample Scorecard
Key Credit Risk Portfolio Metrics Actual Results

2016 Needs
Goal Very Good Satisfactory Improvement Unsatisfactory 12/31/2013 12/31/2014 12/31/2015 Trend

Past Dues / Total Loans & Leases < 1.00% < 0.75% 1.50% 2.00% 3.00% 1.75% 1.32% 1.02%

NPL / Total Loans & Leases < 1.00% < 0.25% 0.75% 1.50% 2.50% 1.30% 1.10% 0.88%

NPL / ALLL < 20.00% 20.00% 40.00% 60.00% 80.00% 42.00% 26.00% 19.00%

NPL / Capital & Reserves < 30.00% 25.00% 40.00% 50.00% 60.00% 29.00% 16.00% 9.00%

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USE LEADING INDICATORS
1. Use Vintage in Reporting
•
Example: Past Dues by Loan Type and Number of
Months since Origination (not calendar year/quarter)
• Apply to upcoming marketing blitzes or loan ‘specials’
• Compare with changes made in underwriting (policy &
procedures)
2. Line of Credit Utilization
• Individual Customer and/or Industry Concentration
• Compare with other Customers in same Industry
3. Upgrade (Downgrade) Activity – with specific reasons
• Risk Ratings
• Non-Accruals

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USE LEADING INDICATORS
4. Review New Application Trends
•
Approval & Declination Volume & Trends
•
Reasons for Turn-downs
•
Average Credit Bureau (FICO) scores on approved and
declined
• Trends in types of requests or inquiries
5. Review Sales Call Trends
• Credit-worthiness of Prospects
• Reasons for not obtaining their business
• Lenders gravitating to ‘lower-hanging fruit’ when lagging
in production

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USE LEADING INDICATORS
6. Peer Group Comparisons
• Custom Peer Group (similar portfolio mix, demographics)
• Volume changes in Loan Types (Call Report segments)
• Charge-off history during good/bad economic times.
7. Learn from Others
• Spilled Milk articles
• FDIC: Material Loss Reviews
• Reasons for failed institutions
• Networking & Risk Management Conferences

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LPM: A CONTINUAL PROCESS
Credit
Culture

Manage Policy &

Risk Procedures

Report Assess
Exceptions Risk

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TRUE LOAN PORTFOLIO RISK
MANAGEMENT

A profound shift...
From: Managing Credit Risk Upon Discovery
To: Scenario Testing & Capital Planning

“It’s not too late to start, but it’s later than you
think.”
-Mike Wear
(an old Credit Guy)

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THANK
YOU

ADDITIONAL MATERIAL PROVIDED – SEE

STUDENT WEBSITE

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