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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

Bank Asset Quality

Posted by Wendell Brock on Tue, Mar 02, 2010

The Risk Management Association (RMA) just released 2009 Q4 figures showing that the downward slide of bank asset quality is beginning to level off.

The RMA is a nonprofit with 3,000 institutional members whose goal is to implement sound risk principles in the financial sector. Their Risk Analysis Service data report was released in conjunction with Automated Financial Systems, Inc., and is the self-professed only gauge of comprehensive credit risk. The data utilize figures from 17 top-tier banks.

Showing Signs of Recovery

From the press release: "The leveling off of the deterioration of commercial asset quality from the third to fourth quarter is a positive indicator that the economy is showing signs of recovery," said William F. Githens, RMA president and CEO. "However, the business banking sector continues to be a concern and is substantially underperforming the middle market and large corporate lines of business."

But while the rate of decline in asset value for big banks is only beginning to level off, specialty lenders are enjoying quicker successes. AmeriCredit, CapitalSource, Allied Capital Source, and CIT Group all posted 52-week high stock prices (TheStreet).

CIT GROUP

CIT Group, a commercial lender to small and medium-sized businesses, took its first bond to market on February 26 after emerging from a brief, month-long Chapter 11 reorganization in December. The bond, offered at $667.2M, represents a portfolio transition from commercial-paper-backed to equipment leases. Hopefully, this shift will lead the way to longer-term solutions to loan portfolio instability and vulnerability.

CIT's bond is issued through the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF), also known as "Bailout #2." CIT got in on the Facility just before its rapidly approaching final monthly application deadline of March 4.

It's a start, but CIT needs to secure other, low-cost funding that doesn't come from the government. Their bankruptcy had followed on the heels of nine consecutive losing quarters that totaled over $5B.

Whether CIT Group-and other lenders-will be able to remain solvent after TALF's discontinuation remains to be seen. What we know, though, is that small businesses are counting on the success of CIT and similar lenders.

Word on the Street

A recent CIT report-auspiciously titled "Lessons Learned-A Case for Greater Optimism" -surveyed owners and executives of 220 American small businesses (as defined by annual revenues from $1M to $15M) about the close of 2009 and their views of 2010.

Key findings:

  • For 2009, 33% said their revenue "declined," and 26% said it "declined significantly"
  • 64% said it was harder today to manage their company's cash flow than it was 12 months ago
  • 90% agreed that current stimuli does not help them
  • For 2010, a whopping 53% expected their revenues to "grow," and 8% expected their revenues to "grow significantly"
  • 80% said they're now smarter about running their businesses
  • 70% said the recession made them better leaders

Bankers should look at a systems to stress test their loan portfolios in an effort to better manage the risk. There are systems in the market place that will stratify/custom grade loan portfolios, stress test the portfolio along various key data points (not just interest rate stress), provide the probability of loss a portfolio will incur. These systems offer many other items of information that are essential to managing the loan portfolio and its risk, to both the bankers and the regulators.

Topics: Bailout, Bank Risks, Bank Asset, stress tests, loan portfolio, Noncurrent loans, charge-offs

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