Credit Considerations During a Loan Growth Period

The industry is enjoying some measure of loan growth almost all across the board (thankfully, acquisition, development and construction loans are still slightly declining, as are home equity loans). Loan growth is one of the few alternatives available to banks to address margin pressures, and many are beating the bushes for credit.

Many of us moan about compromises on pricing, terms and, even worse, covenants. What is a prudent Chief Credit Officer to do? How do you balance the need for loan growth with prudent credit underwriting?

1. Identify material underwriting exceptions that led to asset quality problems in the past. We all know that MUEs are growing. A good CCO shouldn't necessarily count all MUEs as equal, because they are not. How do you know which ones really matter? Look back. There is no better period to examine the impact of MUEs on the loan portfolio than the past 5-7 years. Analyze your MUEs against losses and find which exceptions produced the most losses. Those are the MUEs you should resist almost at all costs.

   Interestingly, some banks who have engaged in this analysis found that no MUE alone explained most of the losses. Rather, a combination of two or even three MUEs together created the most vulnerable credits. Examples include LTV exceptions coupled with unaudited financial statements.

   In general, the most common MUEs include LTV; debt service coverage; liquidity; leverage; guarantees; and amortization. See how those impacted your own portfolio and you can customize your MUE tolerance to reduce future losses in a high growth environment.

2. Examine reasons for declination. No one likes the CCO who is Dr. No. Often even collaborative CCOs are blamed for lack of loan growth. Taking a look at the reasons for declination and reviewing those with both the credit folks and the RM leaders is a worthwhile process. It may not necessarily vindicate the CCO, but it can lead to building a hierarchy of "pain points", or areas where the most loans were declined. Once you know what those are, you can reevaluate which ones can be relaxed and when, and which ones are carved in stone. Either way, you will know what percentage of future declinations on average will be associated with those reasons and make a business decision whether to relax them or not, based upon your risk appetite and need for loans.

   This process should be ongoing, especially the meeting with lenders to resolve declination issues through necessary policy changes following the data review. The benefits of the process are many, and include improved communications with the line; reduced policy exceptions; and improved loan growth.

3. Pre-emptive look at concentration threats. The credit department should look at loan production continuously to evolve concentration threats and give the line a heads-up early on about types of loans or geographies that are about to reach their limit. Your CRM system is an excellent place to start. It will show you pipelines and anticipated loan closings which, in turn, will help you predict where the portfolio is growing, and curb unwanted growth in advance of the RMs looking for that business. This information credit appetite in a dynamic fashion and help the RMs avoid wasting time on unwanted deals.

   Some banks color code concentration areas to visibly show which ones are getting close to their limits. It's an easy visual aid to communicate where the bank's loan appetite is.

4. Watch out for those LPOs. The lending business has many cowboys, and they don't all live in Texas or Wyoming. The RMs that are geographically close to the CCO and are part of the bank system are less likely to become cowboys (although many exceptions do happen). Loan Production Officers have more opportunities to go off the ranch and pursue deals and sectors more aggressively. One effective way to facilitate LPO acculturation is to deploy an experienced leader from the home office in those locations. An organic leader will communicate the boundaries through daily interaction and help integrate new RMs into the organization's credit culture.

5. Product vetting committee. Product innovation increases during times of growth pressures. It is therefore helpful to have a small committee comprised of both line and staff people, including Compliance and Risk personnel, to discuss product innovation on the commercial side even before it occurs.

6. Hire the right people. This is always true, but especially during these times. If you're going after C&I deals, don't hire CRE RMs. If you're going up-market, don't hire from small banks. If you're seeking credit diversification, don't hire elephant hunters. This sounds reasonable and possibly should not even be mentioned, yet we've all seen the mismatches we bring upon ourselves through bad hires of good people whose expertise doesn't fit the bank's strategic direction.

   Further, consider having a credit person interview your RM prospects. Ask them for several examples of transactions that were on the fringe for them to get a real sense of what they consider risky. If their definition of fringe is similar to yours, they are much more likely to bring you deals that are in your wheelhouse.

7. Don't over-engineer. Be willing to change your practices if you're proven to be too conservative. Analysis of reasons for declination and your CRM system can show you if your staff is too conservative, or if your transactions are over-structured. If so, take action and change. It will not only build your credibility as a true partner but also facilitate good loan growth.

8. Use ex-line people for loan review. The loan review function shouldn't be a "gotcha" function. It should be collaborative, independent, strategic, and it should avoid the "check the box" mentality we see way too often. Loan review should provide insights on the portfolio and credit processes.

   Loan review typically focuses on classified loans and large credits. It is good practice to also examine in detail the lowest pass grade loans, which will tell you what might be coming down the pike, as well as a good sample of smaller loans, since those are typically sloppier. Another important review aspect is whether the loan was booked as approved. All of us have controls in place to ensure this happens, and yet we still have problems with this misstep.

9. Concentrations. Examine concentrations across many variables: by capital, geography, business type etc. Further, start from an ideal balance sheet structure, and then develop your limits accordingly. A fortress balance sheet is a key asset, and concentration limits can be used to build such a balance sheet.

This isn't the time to tighten up credit standards. It is the time to work collaboratively with the line to strike a good balance between what the market dictates and what the balance sheet needs.