Lecture Materials

LOAN PORTFOLIO MANAGEMENT – YEAR 1

George E. Ruth Rosemount, Minnesota gruth_1@yahoo.com

651-328-3833

August 9, 2017

1

LOAN PORTFOLIO MANAGEMENT YEAR 1Wednesday August 9, 2017

Intersession Project

1

Project Overview

• Three Sections

• Most done in 15-25 pages

• Do not copy and insert: mission statement, loan policy, or ALM

• Double space, pdf format

• Results of research and interviews

• Most grades within 30 days

• Cover page: name, bank name, and class year

2

2

Gather Information

• Board of Directors loan reports, loan review reports, UBPR, Call Reports, and other internal credit reports

• Review questions

• Schedule interviews

3

Regulators, consultants, non-bankers

• Select a bank

• Use UBPR and call report results

• If possible, interview the bank

• If no interview, explain what you would expect

• Research competitors results to compare and infer what the bank probably does

• Research the market to compare results

4

3

Section 1

Credit risk management: questions are a guide

Does risk philosophy tie into the internal reporting, processes, and approval structure?

Use various reports to determine how the bank applies soundness, profitability, and growth

Review various reports and perform analysis of data

Interview: Board of Directors, CEO, Senior Lender, Lenders

5

Loan Grading/ Risk Rating

• Explain loan grading (risk rating) system

• Determine risk rating changes by lender, loan review, and regulators

• Effectiveness of monitoring

• Use in stress testing and pricing

• Upgrades and downgrades

• Migration

6

4

Codes

• NAICS codes

• Collateral codes

• Purpose Codes

• Use of codes in reports to Board of Directors

7

Concentration Limits

• What is largest loan willing to lead verses legal lending limit?

• What are limits by each major segment?

• Are limits percentage of capital or loans?

• How are limits determined and reviewed?

• How is co-variance used in establishing limits?

• If approaching a limit, is the limit just raised or are credits declined?

8

5

Sub-limits

• Review concentrations by NAICS code

• Look for larger concentration

• What are sub-limits or what should the sub-limit be?

9

Loan Committee

• What is purpose: training, discussion, or approval only?

• How effective is loan committee?

• Review loan origination dates verses first problem loan date to determine how quickly loan deteriorated

• Membership and purpose

10

6

Loan Review

• Who performs- if internal what is background in credit?

• External frequency and sample size

• Frequency of reviews and information

• What happens with reports?

11

Example

• Bank is family owned, conservative and vision is based on service

• Risk rating system 1-9

• Exam has 5 or more risk rating changes

• NAICS codes inputted but not in reports

• No co-variance because of size

• Large lending limits

• No loan review process

• High losses during last recession

12

7

Recommendations

• How effective does bank balance soundness, profit, growth?

• Make specific credit recommendations

• Connect the dots

13

Section 2

• Stress Testing

• How are various loan types stress tested at origination?

• Gather information on key variables

• Explain the banks current model(s)

• Discuss what are margins compared to competition?

• Use DFAST/OCC model to perform a stress test or summarize banks model if comparable

14

8

Stress Home Equity

• How are consumer home equity stress tested?

• How often are “soft” pulls done on credit bureaus?

• How does bank monitor renewals?

• How is usage monitored?

15

Stress Ag Credits

• How are credits stressed at origination?

• Are yields, input costs, and commodity costs stress tested?

• How are variables monitored for term loans?

• How are maximum loan to value for acreage determined?

• Is bank refinancing operating loans into term real estate loans?

16

9

Stress Commercial Credit

• How are credits stress tested at origination?

• Are sales declines, changes to cost of goods sold, operating expenses, days accounts receivable, days inventory, and days accounts payable stress tested?

• How are annual reviews stress tested?

• How are term loans verses lines of credit stress tested?

17

Portfolio

• This is NOT ALM!!!

• This is NOT Capital Planning!!!

• How is overall portfolio stress tested by senior lender, CEO, or Board of Directors?

• How is capital impacted by portfolio stress test?

• Is portfolio broke into segments?

• How is co-variance used?

18

10

Primary Segment

• Explain how you would stress test the banks primary concentration

• What variables would you use and why

• Perform a stress test on this segment

19

Portfolio

• If bank currently has a method to stress portfolio (not ALM), explain the system and results

• What have the historical results been?

• Prior to the recession what did the model say?

• How well did the model perform during the recession?

20

11

Loan Grading

• Analyze the effectiveness of the banks loan grading system

• What are the components so of the grading system?

• Number of changes by outside regulators

• Migration by loan type

• Review loans and previous grades-- timeline

21

ALLR

• What is loss history by segment?

• How is bank preparing for possible CECL changes?

• How does bank analyze migration of loan grading?

• What other factors are considered and how are results adjusted?

22

12

DFAST

• How does the bank use DFAST currently?

• What are the different levels used to stress capital?

• How much can the portfolio deteriorate?

• Use OCC model to stress portfolio or analyze banks stress model and results

23

Stress Example

• Consumer loans are not stress tested

• AG and/or Commercial are stress tested at origination for a two percent rise in interest rates

• No stress testing at annual review

• No stress testing of largest industry segment

• Because of size, under $10 Billion, not required to portfolio stress test

• Stress test done by outside using rise in interest rates

24

13

Recommendations

• What do you recommend to improve your current stress testing process?

• What are the strengths and weaknesses of current process?

• If the bank does not perform stress testing at origination, explain why.

• If the bank does not perform a portfolio stress test, explain why

• Connect the dots to first section

25

Section 3

• Loan Pricing

• What are current models?

• Explain how credit risk pricing is used?

• What is role of competition?

• Listen to Farin webinar

• Use Farin model to test two loans

• Tweak and summarize results

26

14

Current model

• Components of the model(s)

• May have a consumer, residential mortgage, and commercial/agriculture models

• Explain how model(s) is used and how often reviewed

27

Risk Based Pricing

• For floating rate loans, how does bank determine change in risk?

• How does bank price for risk?

• What is the look back period for each segment of the portfolio? (This may or may not be the same as ALLLR)

28

15

Model Two Loans

• Select two loans to model

• Loans must be one consumer or residential mortgage and one commercial or agriculture

• Use Farin System to model

29

Tweak the Test Cases

• Tweak the test cases using one or more of the following: fees, rates, terms, relationship

• Explain the results

• What is the recommendation

30

16

Example

• Consumer loans are all priced same based on credit score

• AG/Commercial loans are negotiated based on what lender can get

• Limited use of fees or other requirements

• Loan grading is not part of pricing

• Meet competition to not loose the deal

31

Pricing Recommendations

• How should current models be changed?

• What recommendation do you have regarding risk based pricing?

• What type of loans should use a pricing model?

• How will a pricing model be used in an annual review without a rate change opportunity?

32

17

Connect All the Dots!!

• Conservative

• Risk Rating

• NAICS

• Concentration Limits

• Stress individual loans

• Stress Portfolio

• Pricing Model

• Price for Risk

• Competition

33

Questions

• Grader and Contact for questions:

• George Ruth

• gruth_1@yahoo.com

• 651-328-3833

• Calls returned same day or next day

• E-mails returned same day or next day

34

18

Credit Questions

• Effectiveness of current culture will be measured in next recession

• Loan grading, concentration limits, NAICS, Co-variance, Lending Committee

• Stress Testing Individual Loans at origination and annual review

• Effectiveness of loan grading

• Migration of risk ratings and ALLLR

• Portfolio stress

• Pricing system, modeling, and risk

• Use price model to sell based on risk, service

35