Sometimes, to make sure you’re taking steps forward, it helps to look a long ways back.
Consider this passage from an Office of the Comptroller of the Currency (OCC) guide on managing loan portfolios: “If a bank lacks adequate data on each loan or does not possess a system to ‘slice and dice’ the data for analysis, management’s ability to manage the loan portfolio is compromised.”
That advice dates to 1997, practically the Stone Age of the Internet and modern computing power, mobility, and versatility.
And yet nearly two decades later, many financial institutions lack the technological capability to optimally manage their loan portfolios.
Some still don’t adequately input — or make only half-hearted attempts to track — information that might seem readily apparent at loan origination but becomes cloudy over time, complicating efforts to distill data to identify trouble spots and opportunities.
Others place too much faith in traditional statistics that, while valuable, are trailing indicators, reactive in nature–providing a travel log of where you’ve come but of little aid in determining what corrective action to take to right the course.
Government agencies and private market experts alike recommend that the key to your loan portfolio’s health is a balance of old-school hard data, predictive analysis, and an ability to identify causative anecdotal signs and observe macro economic trends and their likely impact.
Effective loan portfolio management begins with oversight of individual loan risk, as well as the interrelation between risks of individual loans and portfolios, the OCC advises. Also, understanding your financial institution’s credit culture and risk profile is central to successful loan portfolio management.
Manage your loan portfolios with an eye on maximizing growth in the spirit of your credit culture and risk parameters, capitalizing on market trends and voids, while staying in compliance with existing and emerging regulations.
Within that context, assess these components to gauge the health and efficiency of your loan portfolio:
Total portfolio value
This one seems obvious, and bigger for the sake of bigger isn’t the aim. But lending is the economic engine of your operations, so often a robust portfolio equates to a robust operation.
Delinquency and net charge-off ratios, volumes and trends
Even when addressed as flat data, these figures are crucial to identifying and addressing shortcomings in your underwriting, indirect relationships, collections department, overall market conditions, and more. Ongoing analysis and mapping reveals underlying concerns and opportunities, allows for comparison against industry and regional trends, and can bring to light patterns that portend delinquencies and defaults — which could then trigger proactive measures to prevent or lessen those ratios. In this vein, keep a close watch on the end game with troubled debt restructures (TDR). Are your policies and practices paying off?
Again, this statistic must be viewed fluidly, and with an eye on larger market forces that could impact certain loan segments — particularly consumer real estate.
Credit grade trends
Traditionally, financial institutions placed inordinate weight on a borrower’s credit score at loan origination, a fix-it-and-forget-it mentality. Research now indicates that more than 60% of delinquencies and charge-offs can be traced to loans that experienced a drop of two or more grades. Regularly updating credit scores for all loans with outstanding balances allows a financial institution to determine the risk migration of individual loans, loan segments, and the overall portfolio. Going further, parse the data by loan type, loan officer, auto dealer, and the like to refine your operation. Conversely, credit migration models reveal borrowers with improved creditworthiness, offering an opportunity to increase their credit lines or extend new loan offers.
Yield on assets and cost of funds
After years of downward interest rate pressure from the Federal Reserve, there’s nowhere to go but up. And a stronger-than-expected February jobs report that cut unemployment to 5.5% — a level not seen in seven years, and viewed as full employment — prompted industry analysts to almost universally predict a June rate hike, rather than September as previously expected. Your financial institution should have contingency plans in place to combat interest-rate risk, and be ready to put them into action after years of false starts.
Portfolio diversity: From the twin standpoints of profitability and compliance, diversity of loan type and quality is crucial. During the long slog out of the recession, many financial institutions grew too conservative, gravitating toward the alleged promise of “sure money” through A and B paper and focusing more on the risk than reward — and in the case of credit unions, some would say obligation as a matter of principle — of backing C, D, and E grade loans. They missed out, big-time, as the rising tide of the recovery tended to float most boats. Also, examiners in recent years increasingly have placed emphasis on concentration risk. Financial institutions are well-served to diversify portfolios broadly across consumer and business channels, and within those categories as well — servicing mortgages, home equity lines, new- and used-auto loans, credit cards, personal loans, and avoiding too much exposure within a certain region or industry or size the business operation.