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BirdsEye View

thoughts about credit in 2011
As the 2011 budgeting process gets into third gear and the pressure for loan growth (without much credit risk, of course) intensifies, I have some thoughts I’d like to share with you.
 
Give the commercial bankers back their dignity. Your RMs feel beaten: by their customers, their management and their peers. After two+ humbling years, they find they can get no respect at credit committee and are no longer on sure footing as they negotiate credits. I know what you’re thinking. You’re muttering, “It’s about time!”. That might be so, but if you want quality loan growth, things need to change some.
 
My first suggestion is, get far more crisp on what you’re looking for in credit. Specify not only debt service coverage ratio or global cash flow, but offer calculations such that the credit analysts can easily follow your logic. Consider developing a quick “look-see” step to see if a prospect passes the “laugh test” before the RM gets too deep into the credit only to be rebuffed later in Committee and embarrassed by the prospect. Be as specific as possible in terms of your “sweet spot” for loan size, industry, customer segment, loan-to-deposit expectations, etc. etc.
 
Use segmentation to identify your target prospects. For example, we all know that health care is growing, but which health care segments are stable and likely to need credit extension? For example, are you interested in financial partnership buy-in into cosmetic dentistry practices, or only into basic dentistry practices? Will you finance Lasik surgery equipment or only dialysis equipment? Etc. The more specific you are upfront, the better results you will get – both in credit quality as well as loan growth.
 
As you provide guidance to your RMs regarding your “sweet spot”, it is important to inform them of your concentrations limitations and appetites. Granular and finely sliced concentration reports are par for the course these days, and rigorous stress testing to ensure your current limits are appropriate is also an essential ingredient. Stressing real estate to variables such as the ones below is a first step to lender guidance.
 
·                      Debt Service Coverage Ratio;
·                      % leased up;
·                      Owner occupied vs. non owner occupied;
·                      % of risk-based capital;
·                      By primary collateral;
·                      Tenant exposure (e.g. how many loans or $ amount do you have that is dependent on Wal-Mart as a tenant)
 
And what about participations? Those dried up, thankfully, as we discovered that syndication groups did not have as much in common as we thought. We realized that participating with small banks which had no experience in sizeable credits didn’t work too well. Neither did participations with mega-banks which controlled the credit and resolved it based upon a $1 trillion balance sheet as opposed to a $10 billion one. The need for participations remains, but the acceptable opportunities are scarce. 
 
Consider building your own “club” for participating with like-minded institutions. Identify the following:
 
·                    Who are acceptable partners?
·                    Do you have a participation-experienced attorney? Specific experience is key
·                    Do you have a standardized participation agreement that has been vetted by your “club”?
·                    Have all the club members’ CCOs met and agreed on a compatible credit philosophy?
·                    Are all club members not too big and not too small to handle the credits you’re interested in?
 
Once you have answers to these questions, participations become more profitable in the long-run.
 
Another rock on our shoe is exceptions. I have several suggestions on those:
 
·                    Ask Risk, Compliance and Credit to select the ten top critical exceptions and make those non-negotiables at loan inception
·                    Separate exception reporting for loans at underwriting and then today (to open the door to exception rehabilitation); set portfolio limits on both
·                    Tie critical exception violations to RM incentives compensation in a meaningful way (vs. a 10% penalty)
·                    Be reasonable; for example, how about excluding insurance exceptions from the list? Instead require force place insurance when proof of insurance is not available or obtain a blanket bond. Some banks don’t require insurance below a certain amount. Too many exceptions will result in no improvement since the task will appear (often truthfully so) hopeless
 
RMs like large loans. That’s a good thing if they are credit-worthy. A QUARTERLY review of all large loans, not only those graded below pass, helps focus the RMs’ attention on the downside of lending large amounts and ensures that you have a timely and realistic view of your largest exposures.
 
A word about loan administration. The importance of this function is greater than ever. As we enter 2011 and the NPA pipeline hopefully ebbs, loan administration must ensure that we are not getting right back into the soup with poor administration, collateral management, timely financial statements, guarantor PFSs etc. This department is always important, but even more so during times of loan growth.
 
In sum, 2011 is the year to look outward and grab market share. Just make sure you do so prudently and with clear expectations shared by all: executive management, RMs and the credit side.