BankNotes ...

Loan Portfolio Regulatory Requirements - Intense Portfolio Analytics

Posted by Wendell Brock on Fri, Apr 23, 2010

As the financial crisis deepened, regulatory requirements for financial institution's loan portfolios, both banks and credit unions, are much more stringent.  The thought is that institutions can no longer book loans and forget about them; they must go back regularly and revisit the value of the asset backing the loan and the credit worthiness of the borrower as well as other items that may change.  Considering the national financial crisis, many people have experienced changes in their personal and business finances.

As financial institutions prepare for or respond to an examination, questions around the loan portfolio are asked: what are the examiners asking for? How deep do they want the bankers to drill to find issues with the loan portfolio? What kind of data do they want from the institution? You may say, "but my institution is clean with very few problem loans, I won't need to do any of this research" - think again. They are also looking for loans that could go bad or the data to defend a clean portfolio.

Below are a few items taken from a regulatory agreement between a financial institution and their regulator, these are by no means comprehensive, nor are they the same for each regulatory agency, but each is similar in their requests:

"The Board shall develop, implement, and thereafter direct the Bank's management to ensure the Bank's adherence to systems which provide for effective monitoring of:  

(a) early problem loan identification to assure the timely identification and rating of loans and leases based on lending officer submissions;

(b) statistical records that will serve as a basis for identifying sources of problem loans and leases by industry, size, collateral, division, group, indirect dealer, and individual lending officer;

(c) adequacy of credit and collateral documentation"

The regulators are asking for probable loss modeling of the loan portfolio, which loans are likely to go bad based on objective statistical data. Along with stratification analysis based on loan officer, industry, size, collateral, division, group, indirect dealer; additionally the institution may need to show the stratification of loan grading, FICO scores, FICO migration, zip code, branch office, loan size, or any other important data point. The institution should know its loan migration, how many "A" grade loans in a portfolio have shifted over time to "B" or "C" or lower grade loans.

They also want the assets backing the loans reanalyzed to make sure there is still enough value behind the loan if a foreclosure or repossession is necessary. Real-time asset valuations combined with stress testing the portfolio will be the key; how does the financial institution get objective real-time values on the assets that back a diverse loan portfolio that includes consumer, residential and commercial real estate for thousands of loans? 

The Agreement goes on to state that the financial institution will...

"The Board shall within sixty (60) days employ or designate a sufficiently experienced and qualified person(s) or firm to ensure the timely and independent identification of problem loans and leases.

"The Board shall within sixty (60) days ensure that the Bank's management is accurately analyzing and categorizing the Bank's problem loans and leases.

"The Board shall establish an effective, independent and on-going loan review system to review, at least semi-annually, the Bank's loan and lease portfolios to assure the timely identification and categorization of problem credits. The system shall provide for a written report to be filed with the Board after each review and shall use a loan and lease grading system consistent with the guidelines set forth in "Rating Credit Risk" and "Allowance for Loan and Lease Losses" booklets of the Comptroller's Handbook. Such reports shall include, at a minimum, conclusions regarding:

(a) the overall quality of the loan and lease portfolios;

(b) the identification, type, rating, and amount of problem loans and leases;

(c) the identification and amount of delinquent loans and leases;

(d) credit and collateral documentation exceptions;

(e) the identification and status of credit related violations of law, rule or regulation;

(f) the identity of the loan officer who originated each loan;

(g) loans and leases to executive officers, directors, principal shareholders (and their related interests) of the Bank; and,

"The Board shall ensure that the Bank has processes, personnel, and control systems to ensure implementation of and adherence to the program developed pursuant to this Article.

In addition to the above requirements, this will require stress testing of the portfolio across several data points including, loan to value compression, FICO score movement, as well as interest rate adjustments. How will each type of loan portfolio respond to multiple, simultaneous stresses?

The board of directors has a lot of work to do in assisting the management team of the institution. The regulators are asking for more involvement with the institution and its problem loans requiring, objective defensible grading and stratification analysis, along with probable loss modeling, stress test simulations, and real-time asset valuation, of 100 percent of the portfolio. Moreover, if you think that your institution is completely clean - you are not on a problem list or don't have very many problem loans - well now you will have to prove it to the regulators.

Real, defensible, comprehensive portfolio analytics will be the solution - it will take a banker/CFO weeks or months to develop such a custom model for your institution in an excel spreadsheet. Or will it require anew strategy?

Topics: Interest Rates, regulators, stress tests, Regulations, Loan Grading, Asset Valuation, Stress Test Simulation, Portfolio Analytics, loan portfolio

Third Quarter 2009 FDIC Banking Profile

Posted by Wendell Brock on Wed, Nov 25, 2009

FDIC member institutions' earnings improved this quarter to a modest $2.8 billion, which is significant over last quarter's net loss of $4.3 billion and third quarter of 2008 of $879 million. Loan loss provision continued to affect the profitability of the industry as banks continued to cover their bad assets. Growth in securities and operating income helped the industry realize the profit, with 43 percent of the institutions reporting higher profits this quarter over the same quarter last year.  Just over one in four banks reported losses this quarter of 26.4 percent, which is slightly up from 24.6 percent a year ago.

Net Interest Margin, ALLL

Net interest was higher this quarter, rising to a four-year high of 4.6 billion. The average net interest margin (NIM) was 3.51 percent, slightly higher than last quarter. Most banks, 62.1 percent, reported higher NIM than last quarter; however only 42.2 percent had an NIM increase year over year. Provisions for loan and lease losses increased and total set aside, remained over $60 billion for the fourth straight quarter, rising to $62.5 billion. While the quarterly amount banks set aside was only 11.3 billion, $4.2 billion less than the second quarter, it was 22.2 percent higher than last year. Almost two out of three institutions, 62.6 percent, increased their loan loss provisions.

Net Charge Offs Remain High

Loan losses continued to mount, as banks suffered year over year increases for 11 straight quarters. Insured institutions charged off a net of $50.2 billion this quarter, a $22.6 billion increase or an 80.5 percent increase compared to third quarter of 2008. This is the highest annual charge off rate since banks began reporting this information in 1984. All major categories of loans saw significant increases in charge offs this quarter, but losses were largest amongst commercial and industrial (C&I) borrowers. While noncurrent loans continued to increase, the rate of increase slowed; noncurrent loans and leases increased $34.7 billion or 10.5 percent to $366.6 billion, which is 4.94 percent of all loans and leases. This is the highest level of noncurrent loans and leases in 26 years. The increase of noncurrent loans was the smallest in the past four quarters.

Eroding reserves

The reserve ratio increased as noncurrent loans increased, however the spread continued to widen. While the industry set aside 9.2 billion, 4.4 percent in reserves, which increased the reserve level from 2.77 percent to 2.97 percent. This increase was not enough to slow the slide - it was the smallest quarterly increase in the past four quarters and the growth in reserves lagged the growth of noncurrent loans, which caused the 14th consecutive quarterly decline in this ratio from 63.6 percent to 60.1 percent.

Loan Balances Decline Deposits Are Up

Loan and lease balances saw the largest quarterly decline since the industry started keeping track of these numbers in 1984; they fell by $210.4 billion or 2.8 percent. Total assets fell for the third straight quarter; assets at insured institutions fell by $54.3 billion, which follows a decline of $237.9 billion in the second quarter and a $303.2 billion decline in the first quarter. Deposits increased $79.8 billion or 0.4 percent during the third quarter, allowing banks to fund more loans with deposits rather than other liabilities. At the end of the quarter deposits funded bank assets was 68.7 percent, the highest level since second quarter 1997.

Troubled Banks Increase

The number of reporting insured institutions at the end of the quarter was down to 8,099  from 8,195; there were fifty bank failures and forty-seven bank mergers. This is the largest number of banks to fail since fourth quarter of 1992, when 55 banks failed. The number of banks on the FDIC's problem list increased from 416 to 552 at the end of the second quarter.

During the quarter, the number of new banks chartered was three.  This is the lowest level since World War II. This begs the question on what is the best way to get new capital into the banking industry. Should we recapitalize the existing banks including those in trouble? Or, should we start fresh with a new bank that can build a new, clean loan portfolio?

Another Item

CREED - a 501(c)3 nonprofit has started a Crowdfunding project/contest to help a small business - Look at the opportunity to be a part of something truly great! We will follow this closely as we are strong supporters of CREED.

4M5EDCNY9JWB

Topics: Interest Rates, FDIC, banks, Community Bank, FDIC’s, Loans, Bank Capital, CREED, capital, equity capital, De Novo Banks, Noncurrent loans, community banks, Crowfunding

FDIC Banking Profile

Posted by Wendell Brock on Mon, Dec 01, 2008

FDIC Reports Continued Deterioration in Earnings Performance, Asset Quality

 

The FDIC’s third quarter, 2008 Quarterly Banking Profile was released on November 25, 2008. The industry snapshot shows a continuation of negative trends, including depressed earnings and deteriorating asset quality. The report also provides detail on the proposed changes to the FDIC’s assessment system.

 

Earnings continue to slide

 

Greater than 58 percent of member institutions reported year-over-year declines in quarterly net income, while 64 percent generated a reduced quarterly return on assets (ROA). Profitability issues appear to be magnified at the larger banks; institutions with assets greater than $1 billion experienced a 47-basis point, year-over-year ROA decline. Community banks fared somewhat better with a 25-basis point decline. Nearly one-quarter of member banks failed to earn a profit in the quarter; this is the highest level for this metric since the fourth quarter of 1990.

 

Income a mixed bag  

 

Member banks reported declines in several categories of noninterest income, including securitization income and gains on sales of assets other than loans. Losses on sales of bank-owned real estate increased almost six-fold to $518 million. Loan sales, however, showed a marked improvement with net gains of $166 million. This compares to net losses of $1.2 billion in the third quarter of last year.

 

Net interest income also improved by 4.9 percent versus a year ago. The average net interest margin (NIM) remained flat with last quarter, but rose 2 basis points relative to the year-ago quarter. This trend was more pronounced among larger institutions.

 

Credit losses still piling up

 

As expected, expenses related to credit losses drove much of the earnings decline. Industry-wide, credit loss-related expenses topped $50 billion, eating up about one-third of the industry’s net operating revenue. Aggregate loan-loss provisions tripled from the year-ago level, reaching $50.5 billion in the quarter. Net charge-offs increased by 156.4 percent to $27.9 billion, with two-thirds of the increase related to loans secured by real estate. Charge-offs related to closed-end first and second lien mortgages, real estate construction and development loans, and loans to commercial and industrial borrowers all showed increases well in excess of 100 percent. The quarterly net charge-off rate jumped 10 basis points sequentially to 1.42 percent; this is the highest quarterly net charge-off rate since 1991.

 

Past-due loans still rising

 

Noncurrent loans and leases, defined as being 90 days or more past due or in nonaccrual status, increased by $21.4 billion sequentially to $184.3 billion. Nearly half of this growth came from closed-end first and second lien mortgages. The percentage of loans and leases that are noncurrent rose to 2.31 percent, which is the highest percentage recorded since 1993.

 

Loan-loss reserves ticked up by 8.1 percent, bringing the ratio of reserves to total loans and leases to 1.95 percent. Reserves to noncurrent loans fell to $0.85, which is the lowest level recorded since the first quarter of 1993.

 

Watch list grows 46 percent, number of new charters shrinks

 

Nine banks collapsed during the third quarter, and another seventy-three were merged into other institutions. While the number of failures marks a high point since the third quarter of 1993, the growth of the FDIC’s list of problem banks indicates that there are still rough times ahead; an additional fifty-four banks were added to the watch list, bringing the total number of problem banks to 171.

 

Twenty-one new institutions were chartered during the quarter. This marks a decline from the twenty-four new charters that were added last quarter.

 

Noninterest-bearing deposits rise, DIF reserve ratio declines

 

The total assets of all FDIC-insured member institutions rose 2.1 percent to $273.2 billion during the quarter. Most of the increase, some 57 percent, came from noninterest-bearing deposits. Interest-bearing deposits on the other hand showed a slight decrease of 0.3 percent.

 

Insured deposits continued an upward trend, rising 1.8 percent on top of a second quarter increase of 0.6 percent. Fifty-eight percent of member institutions reported an increase in insured deposits, 42 percent reported a decrease and the remainder reported no change.

 

The Deposit Insurance Fund decreased by $10.6 billion, primarily due to an $11.9 billion increase in loss provisions for bank failures. As of September 30, 2008, the reserve ratio was 0.76 percent, down 25 basis points from three months prior. Nine insured institutions failed during the quarter, bringing year-to-date failures to thirteen; those thirteen failed institutions had combined assets of $348 billion and are estimated to have cost the DIF $11 billion.

 

Restoration plan involves increases, changes to risk-based assessments

 

The FDIC adopted a restoration plan on October 7 to increase the DIF’s reserve loss ratio to 1.15 percent within five years, as required by Federal Deposit Insurance Reform Act of 2005. In accordance with the plan, the FDIC Board approved the publication of a notice of proposed rule making to increase the assessment and shift a larger proportion of that increase to riskier institutions. For the first quarter of 2009, the FDIC seeks to increase assessment rates by 7 basis points across the board.

 

The proposed assessment system, to be effective April 1, 2009, establishes base assessment rates ranging from 10 to 45 basis points for Risk Categories I through IV. Those base rates would then be adjusted for unsecured debt, secured liabilities and brokered deposits. The adjusted assessment rates would range from 8 to 77.5 basis points. 

 

 

Topics: Interest Rates, FDIC, Banking, Loans, Credit, Deposits, Third quater, ROA

Subscribe by Email

Most Popular

Browse By tag

To Obtain a White Paper

BankNotes

BankNotes© is published by De Novo Strategy as a service to clients and other friends. The information contained in this publication should not be construed as legal, accounting, or investment advice. Should further analysis or explanation of the subject matter be required, please contact De Novo Strategy at subscribe@denovostrategy.com.