Filling The Gap: What Examiners Really Need From Your Loan Portfolio Analysis
November 2015

The full weight of the regulatory layers added since the financial crisis have been taking a toll on credit unions, say many industry leaders.

Lending operations shoulder a particularly heavy share of that burden, a small but palpable dose of bitter amid an otherwise incredibly sweet story of lending success rooted in consumer confidence and a business environment at long last conducive to capital investment.

But don’t allow the sometimes vague and amorphous regulatory landscape to hamper your optimism. Minimize concerns about your upcoming examiner visit by concentrating your preparations on the areas that most concern examiners.

Industry resources and surveys on this topic abound. NCUA often signals its intentions, consultants regularly blog about specific land mines you might encounter, and twice annually the Office of the Comptroller of the Currency publishes a particularly effective and predictive tool, its Semiannual Risk Perspective.

Additionally, some common sense rules apply that predate this avalanche of newly mandated procedures and policies, tenets on which some of the nation’s strongest credit unions have built their lending operations.

Certainly, individual examiners have their own predilections, and more broadly, regulatory bodies can be guilty of focusing an inordinate amount of attention on the topic du jour. But while you must be wary of those variables, and keep tabs on changing industry conditions, by general rule examiners have indicated what they really need to see in your loan analysis.

One recent, tangential trend has emerged in recent years: Examiners have become increasingly comfortable with and confident in credit unions that rely on automated loan processes conducted with loan portfolio management software fueled by multifactor data analysis, because that combination reduces a credit union’s risk exposure and creates operational efficiencies.

Do as you say. Consider this step the overarching mantra for your compliance approach. How closely does staff adhere to your stated policies and procedures? Have they developed workarounds or intentionally strayed from controls you implemented? Demonstrating institutional control reassures examiners of your operation’s consistency, which imbues trust in your practices. This can spell the difference between the examiner taking an inquisitive or interrogative approach. The latter can drag out the exam process and invites nitpicking and greater oversight.

Establish a strong credit risk culture. This goal goes hand-in-hand with the prior goal. Provide a framework for your staff to make decisions that take into account both short-term goals such as portfolio growth and long-term goals like members’ well-being, and organizational stability and reputation. Implement multifactor, data-driven analysis of loan applications, with a system of credit migration monitoring after loan issuance. Encourage collaborative decision making to better draw out red flags or opportunities.

Practice defensible underwriting. Thanks to increased consumer demand and prodding from legislative and regulatory bodies, financial institutions that were risk-averse in the post-recession period have loosened their underwriting standards considerably. With the proper controls in place — such as risk-based pricing based on comprehensive data analysis — an aggressive stance can reap tremendous rewards. But avoid forcing the issue by approving borrowers with layered risk factors, particularly in areas of indirect auto lending, asset-based lending, commercial real estate (CRE), and commercial and industrial loans. And offer exceptions in a strategic, mindful manner, with a rigorous monitoring plan.

Be mindful of concentration risk. Balance is essential in any portfolio, whether you’re talking about loans within a particular industry, geographical area, or loan category. Because of the likelihood that the Federal Reserve Board will raise the funds rate sooner rather than later, examiners have been paying special attention to concentration risk in sectors most vulnerable to interest rate risk (IRR), such as CRE. They’re also on guard against portfolios weighted toward volatile industries such as energy.

Don’t “reach” for yield. In this era of shrinking margins, some financial institutions will push the envelope to grow their loan portfolios. OCC cautions against actions such as extending maturities to pick up yield, which could lead to “significant earnings pressure and capital erosion.” Optimize the portfolio within the boundaries of your asset-liability management (ALM) program.

Anticipate major financial system events. For example, nearly half of outstanding home equity line of credit balances will transition from draw period to repayment from now through 2017. As noted by OCC, this could pose interest rate risk from concentrated resets and rising market rates, payment shock from additional principal payments, and refinancing difficulties because of lower property values and conservative lending underwriting standards.

Deliver detailed documentation. Regardless of your relationship with the examiner, and regardless of how well you can articulate the safety and soundness of your loan portfolio analysis, you need to produce proof. A loan portfolio management system can confirm the integrity of your data, and allows you to quickly slice and dice data to produce whatever report an examiner wants to review.


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