loan portfolio management - year 2...2018/07/30 · loan portfolio management - year 2 “loan...

LOAN PORTFOLIO MANAGEMENT - YEAR 2

“Loan Portfolio Management - Strategies & Tools”

Michael A. Wear Senior Credit Analyst

First National Bank of Omaha Omaha, NE

[email protected] 402-871-9067

July 30, 2018

LOAN PORTFOLIO MANAGEMENT:STRATEGIES & TOOLSMICHAEL WEARSECTION LEADER: LOAN PORTFOLIO MANAGEMENTGRADUATE SCHOOL OF BANKING - WISCONSINAUGUST, 2018

© 39 Acres Corporation 1

CREDIT QUALITY

© 39 Acres Corporation 2FDIC: Quarterly Bank Profile 2Q2018

“In calm water,every ship has a good captain.”

-Traditional Proverb


CREDIT QUALITY


ALLL PROVISIONS & CHARGE-OFFS


LOAN LOSS RESERVE


LOAN ACTIVITY


LOAN ACTIVITY

• Loan Volume continues to grow – 9th consecutive year of GDP growth

• Credit Line utilization continues slight decline – 8th

consecutive quarter• Recent record-low Past Due & Non-Accrual levels*

• *During the past 33 years, the banking industry has reported only 12 quarters with a lower PDNA ratio…

…all of which were in the years leading up to the credit crisis in 2007.


-FDIC Supervisory Insights (Winter 2017)

BAD LOANS ARE MADE IN…


-Esther George (Nebraska Bankers Association Credit Conference, 2006)

FORWARD-LOOKING CREDIT METRICS• Out-of-area lending (including whole loan purchases, loan

participations, and shared national credits)• Acquisition, Development & Construction (ADC) lending• Commercial Real Estate (CRE) concentrations• Loan growth exceeding 10% year-over-year

• CAMELS 1-2 Banks • 2013 = 23%• As of 9/2017 = 33%• Of these banks, only 6% indicated standards are loosening


-FDIC Supervisory Insights (Winter 2017)

CRE CONCENTRATIONS

© 39 Acres Corporation 14- AsktheFed (January, 2018)

TROUBLED INDUSTRIESHistorical Volatility:Budget motelsTruckingLoggingGolf CoursesRetailContractors/DevelopersRestaurants

Ever-present:Leveraged Lending


Recent Volatility:Oil & GasAg (producers)Taxi ServicesBig Box RetailIndirect Auto Loans

Leveraged BuyoutsESOP Loans“Enterprise Value”

On your Student Website: IBISWorld’s Industry Risk Scores

Check Out: CNBC’s 50 Disrupter Companies List

THE POTENTIAL IS THERE…


• Capital Expenditure-dependent industries: • Ag, Mining, Utilities, Transportation, etc.• Grow rapidly during economic expansions• Weaken quickly during recessions

• Fintech:• Banks financing non-bank financers • Leasing Companies, Used Car Dealers• Increased financing of sub-prime borrowers• Longer loan terms

• Consumer Discretionary Spending:• Luxury vehicles, high-end restaurants, spas, upper-

upscale hospitality

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. CurryComptroller of the CurrencyRMA Risk Management Conference (11/2015)


ARE WE GETTING LOOSE (AGAIN)?“We still see competition driving underwriting standards [downward]. We still see relaxed covenants.”

• Darren BenhartDeputy Comptroller of the CurrencyRMA Risk Management Conference (11/2016)


MATTERS REQUIRING BOARD ATTENTION

© 39 Acres Corporation 19OCC Semiannual Risk Perspective (Spring, 2018)

• Number of MRA’s concerning Commercial Credit Underwriting:• Up 24% (1Q2017 – 1Q2018)

• Number of MRA’s concerning Commercial Credit Policy Exceptions:• Up 45% (1Q2017 – 1Q2018)

Examples: diminished protective financial covenants, generous cash flow adjustments, limited or no guarantees, longer amortization periods, extended interest-only terms, and higher loan-to-value ratios or advance rates.

EXAMPLE: POLICY EXCEPTION QUESTIONSAsk yourself then others tough questions like:• Are all approval conditions consistently met before closing

the loan?• How prompt are post-closing [pre-funding] requirements

obtained?• Are limited guaranties becoming more ‘the norm’? Are

supporting reasons getting weaker?• Are trade reference checks being made?• Is guarantor liquidity being verified?

Policy exception trends are difficult to spot unless monitoring is consistent. Will someone notice when does the exception become the norm?Failure to enforce your own documentary terms and conditions will severely weaken your case if you go to court.


TRUE LOAN PORTFOLIO RISK MANAGEMENT

A profound shift...From Reactionary: Managing Credit Risk Upon Discovery

To Proactive: Scenario Testing & Incorporate Capital Planning


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


A DIFFERENT PERSPECTIVETraditional Credit

Risk Mgmt.Loan Portfolio

Risk Mgmt.Scope Product Type One PortfolioIncentive Loan Volume Economic Profit

Philosophy Originate & Hold Underwrite & Distribute Risk

Evaluate Transaction, Customer

Loan Segments, Co-variance of

RiskPricing By Product Type Risk-based


CO-VARIANCE EXAMPLE: SUPPLY CHAIN

Housing Starts

Home Builders

Builder’s Suppliers &

Lumberyards

Lumber Wholesalers

Cement Manufacturing

Cabinet Manufacturing

Lumber Wholesalers

Furniture Stores

Home Appliance

ManufacturingFurniture

Wholesalers

Lumber Wholesalers

© 39 Acres Corporation 24OCC Semiannual Risk Perspective (Spring, 2018)

Co-Variance

LOSS EMERGENCE EXAMPLE: TIME LINE

Forward-Looking

• Change in Demand• Economic Cycles• Decline in Sources of

Income

Loss Event

• Loss of Major Customer• Job Losses• Property Values Decline

Discovery• Financial Statement Monitoring• Covenant Violation• Delinquency

Response&

Outcome

• Risk Rating Criticism• Work-out• Charge-off


HOW TO STEP-UP YOUR BANK’S

LOAN PORTFOLIO MANAGEMENT


ROOT LPM IN YOUR BANK’S CREDIT CULTURE

Risk Culture (Appetite)

Policy & Procedures

Loan Portfolio Management


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?


“Conduct Risk” - $321B in fines issued globally.

-- Boston Consulting Group (March, 2017)

3 LINES OF DEFENSE2. 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)


EXAMPLE: MORE GRANULAR RISK RATING MATRIX


3 LINES OF DEFENSE3. 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


EXAMPLE: FILE REVIEW VS. LOAN REVIEWFile Review (technical)

• Compliance with approval terms & credit policy• Financials, DSCR, LTV

Loan Review (risk identification, more strategic)Cash Flow analysisCollateral valuation Loan structure & documentation Industry trends Identify training needs


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 & migration• Policy & Underwriting Exception management• Loan Monitoring - commensurate with risk trends• Adequacy of ALLL


EXCEPTION TRACKING(4 KEY AREAS)


Risk Ratings

Technical Exceptions

Underwriting Exceptions

Policy Exceptions

EXCEPTION TRACKING

Risk Ratings• Individual loans (material borrower changes vs. bank errors)• “Double-dips”• Aggregate Risk Ratings

• By loan segment• Direction, Migration• Overall accuracy

Technical Exceptions• Financials not received per approval• Documentation shortfalls (e.g. missing info, signatures)• Covenant violation without acknowledgment/waiver


EXCEPTION TRACKINGPolicy Exceptions

• Compliance with policy & regulations• Guaranty coverage• Outside market territory• Concentration limit exceeded• Approval authority not obtained

Underwriting Exceptions• Debt Service Coverage 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


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 Semi-annual Risk Perspectives


CONCENTRATION EXAMPLE: MULTIFAMILY


MANAGING CONCENTRATIONSRisk Appetite Statement or 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 or 3 digits of NAICS codes]• Roles & responsibilities of management, lenders, staff• Report types & frequency


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)


MANAGING CONCENTRATIONS• Set Concentration Limits

• Individual Borrower (including related entities)• Loan Type• Collateral Type (CRE property types)• Geography• Bank’s house limit (< legal lending limit)

• Exceeding the 100% or 300% CRE thresholds• triggers robust risk management & higher regulatory

scrutiny

• Approvals required when exceeding Concentration Limits.


EXAMPLES: MANAGING LOAN GROWTHConcentration Management 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


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 = Occupancy (Vacancy), NOI, 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 for your Bank’s portfolio mix


EXAMPLES: 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 or failure of a major customer

relationship(s)


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]


EXAMPLE: MONITORING PORTFOLIO PERFORMANCESample Scorecard


2018Goal Very Good Satisfactory

Needs Improvement Unsatisfactory 2015 2016 2017 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% 31.00% 19.00%

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

Key Credit Risk Portfolio Metrics Actual Results

7 WAYS TO 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• Unsecured Loan utilization (percent of outstandings)

3. Upgrade (Downgrade) Migration – look for common causes• Risk Ratings • Non-Accruals


7 WAYS TO USE LEADING INDICATORS4. Review New Loan Applications

• 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 Calls• Credit-worthiness of Prospects• Reasons for not obtaining their business• Lenders gravitating to ‘lower-hanging fruit’ when lagging

in production


7 WAYS TO USE LEADING INDICATORS6. 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• OCC: Semi-annual Risk Perspectives• Networking & Risk Management Conferences


HOW TO GET THE MOST OUT OF YOUR LPM*Minimum [Traditional] 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 Loans• Debt Service Coverage (DSCR, DTI), Loan-to-Value (LTV),

Monitoring defaults

© 39 Acres Corporation 51*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

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 net profitability, loss rates, etc.)


HOW TO GET THE MOST OUT OF YOUR LPM*Avoid These Pitfalls: 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.


HOW TO GET THE MOST OUT OF YOUR LPM*Avoid These Pitfalls (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


LPM: A CONTINUAL PROCESS

Credit Culture

Policy & Procedures

Assess Risk

Report Exceptions

Manage Risk


TRUE LOAN PORTFOLIO RISK MANAGEMENT

A profound and difficult shift...From: Reactive - Managing Credit Risk Upon DiscoveryTo: Proactive - Scenario Testing & Capital Planning

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


THANK YOU

ADDITIONAL MATERIAL PROVIDED – SEE STUDENT WEBSITE


loan portfolio management - year 2...2018/07/30 · loan portfolio management - year 2 “loan...

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