How to Build a Loan Portfolio That Drives Revenue and Mitigates Risk
December 2015

Many people have reflected on the underlying psychological differences between those who prefer cooking over baking, and vice versa.

Cooks tend to be creative types who enjoy experimenting with new combinations, constantly poking and probing to improve existing recipes and discover new taste sensations.

Bakers, on the other hand, enjoy the structure of exacting directions and the understanding that only by following them precisely will the creation come out of the oven properly.

There’s a good case to be made that building your financial institution’s ideal loan portfolio requires a mixture of those perspectives.

To address safety and soundness concerns internally and with regulators, your lending program must be built on a foundation that unequivocally values policies, procedures, and the integrity of data and documentation.

But you must also create a lending culture in which you reward vision, experimentation, and adaptation — within the boundaries of your strategy and institution’s risk tolerance, of course.

That’s because the perfect recipe for success doesn’t exist. Even if every financial institution shared the same taste for the composition of its lending portfolio, each faces different pressures due to an endless variety and stream of macro- and microeconomic factors. So, financial institutions must constantly adapt to maximize their lending portfolio’s return and mitigate risk.

That said, the components of a strong lending program don’t change. These include:

Superb strategy. Everything begins here. The board and senior management must craft a short-, medium- and long-range plan that outlines objectives and risk tolerance, allowing as much latitude as possible for staff to formulate approaches to meet your goals.

Sound framework. Create and rigorously monitor adherence to policies, underwriting guidelines and procedures consistent with and supportive of the overarching strategy.

Tactical alignment. The short-term business, marketing, and compensation plans must advance the aims enumerated in the long-term strategic portfolio objectives.

Strong credit culture. Develop among lending staff and managers ownership of responsibility not just for underwriting decisions but also ongoing management of credit risk. As the Office of the Comptroller of the Currency has long noted, improper loan structuring or inadequate monitoring can undermine even sound initial credit decisions.

Heightened automation. Initial technology investments more than pay off in the form of reduced operating costs, stronger monitoring capabilities, and quick, evidence-based recognition of market opportunities. Today’s loan portfolio management systems allow for concrete data optimization and intricate data analysis, providing a distinct competitive advantage.

Concentration consciousness. Just as in real estate, it’s all about location, location, location, your portfolio should scream diversification, diversification, diversification — among various loan types but also the creditworthiness of individual borrowers. Not only is a portfolio filled with only A paper likely discriminatory, it’s not going to be very profitable. Subprime lending addresses the needs of real people in your community and also provides much-needed interest revenue.

Logical liquidity. In today’s environment, the spectre of interest-rate risk means financial institutions should address portfolios weighted too heavily to long-term investments. The silver lining of low rates is that your financial institution can package and sell those holdings at a gain, allowing your financial institution to recalibrate quickly.

Capital management. A stronger commitment to enterprise risk management translates not just to better compliance with regulatory demands but also minimizes the required amount of reserve capital, maximizing profitability.

Effective risk modeling. Few prefer playing the “what if?” game more than lending executives. Ensure you are prepared for any number of probable and improbable scenarios by stress-testing your portfolio and developing detailed plans for responding to early market indicators.

Don’t settle. Constantly survey the landscape for lending options that provide better return, and don’t be afraid to trim underperforming sectors — or at least minimize your involvement, in cases where your financial institution has made a philosophical commitment to serving that need.

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