With apologies to famed sportscaster Dan Patrick, you can't stop all bad loans, you can only hope to contain them.
Regulators have long recognized that the initial credit-granting process is a credit union's first defense against credit risk. But they've also highlighted the importance of adequate loan administration in managing credit risk after the loan has been made.
"Weaknesses in credit administration can pose significant safety and soundness issues for the bank," warns the OCC's Handbook on Loan Portfolio Management. "When [Management Information Systems] deficiencies or inaccuracies jeopardize or restrict credit risk management practices, examiners will need to ID the root cause and initiate corrective action."
Monitoring the loan portfolio is vital to ensuring good loans don't go bad. For every loan, lenders start out with what they think is a good loan decision. Somewhere along the way, it can turn out to not be such a good idea.
There are several keys to a credit union's effective loan administration, but here are three to consider as you review your existing loan administration system: Do you get accurate information on a timely basis? Are you taking action where warranted? Can you analyze that data and recognize whether something is amiss? How are you tracking these loan exceptions?
Accurate, timely information. The backbone of loan monitoring is getting updated financial statements, insurance documents and collateral documentation in a timely manner, and accessing that info quickly. Systems should be designed to remind staff of information needs, to automate client correspondence as much as possible, and to track collected data easily.
Action. Effective loan administration systems make it easier for lenders to take active steps to keep the portfolio healthy. This can mean providing information early enough to allow the CU to work with the borrower to avoid late payments, or it can mean taking other action (such as adjusting the risk rating or taking a reserve on the individual loan) as warranted to minimize institutional credit risk.
Analysis that calls out potential trouble spots. Many CUs have to pull loan-related information from the core system and either combine it with data from paper files or manipulate the information (adding to it or performing calculations) in order to monitor the health of the loan. A system that easily provides automated reports of exceptions or that standardizes risk ratings can help lenders perform loan reviews quickly in order to assess whether a borrower is headed for trouble.
There are many ways to track loan exceptions, but here are a few that should be practiced by any CU:
• Systematically identify document exceptions. Regular, systematic and proactive identification of document exceptions is the best way to prevent documents from "falling through the cracks." Many financial institutions may find it difficult to identify exceptions in a systematic and routine way if much of the documentation is contained in physical credit files, or is tracked using spreadsheet programs such as Excel. Collateral tracking and tracking member correspondence via paper files can make it tough to retrieve and centralize information. And spreadsheet-housed data can be prone to more manual and formula errors than if the data were captured in the core or other automated software systems used for analyzing borrower financial data.
• Initiate timely resolution of document exceptions. Resolving document exceptions can be time consuming and costly, given the sheer number of documents that may be monitored on an ongoing basis. An automated loan management system that can generate and track client correspondence and reduce the administrative workload makes the process of resolving exceptions more cost effective.
• Ensure that documentation remains valid and current throughout the loan term. Identifying documentation exceptions before the loan closes is obviously preferable, but sound loan administration and risk management is an ongoing process. Having a loan administration system that bridges the core processing system and underwriting systems can allow an institution to conduct post-closing reviews and periodic checks more easily by developing ticklers and generating member emails, letters or phone lists automatically.
Improving Lending Efficiency
• Analyze patterns in document exceptions. Identifying patterns can point out problems in the origination process, which may prompt changes that can make loan approvals more efficient.
Automated document and covenant compliance reports can get this information into the hands of management and examiners more quickly and efficiently.
Mary Ellen Biery is research specialist with Sageworks.