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PowerPoint Presentation

LOAN PORTFOLIO MANAGEMENT – YEAR 2

Michael Wear Senior Credit Analyst

First National Bank of Omaha Credit Administration

Omaha, Nebraska

&

Owner 39 Acres Corporation

Omaha, Nebraska

mikewear@hotmail.com 402-871-9067

August 4, 2017

LOAN PORTFOLIO MANAGEMENT:STRATEGIES & TOOLSMICHAEL WEARSECTION LEADER: LOAN PORTFOLIO MANAGEMENTGRADUATE SCHOOL OF BANKING - WISCONSINAUGUST, 2017

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CREDIT QUALITY

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FDIC: Quarterly Bank Profile 1Q2016

CREDIT QUALITY

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FDIC: Quarterly Bank Profile 1Q2016

CREDIT QUALITY

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FDIC: Quarterly Bank Profile 1Q2016

CREDIT QUALITY

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FDIC: Quarterly Bank Profile 1Q2015

THESE ARE (CONTINUING) DIFFICULT TIMES…“I doubt there’s been a more difficult time for a bank risk manager in a good many years—certainly not in my lifetime.”“While reserves remain at a high level industry-wide, quarterly provisions are smaller than charge-offs.”

• Thomas J. CurryComptroller of the CurrencyRMA Risk Management Conference (11/2013)

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ALLL PROVISIONS & CHARGE-OFFS

© 39 Acres Corporation 7FDIC: Quarterly Bank Profile 1Q2016

TROUBLED INDUSTRIESHistorical Volatility:Budget motelsTruckingLoggingGolf CoursesRetailContractors/DevelopersRestaurants

Ever-present:Leveraged Lending

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Recent Volatility:Oil & GasAg (producers)Taxi ServicesBig Box RetailIndirect Auto Loans

Leveraged BuyoutsESOP Loans“Enterprise Value”

On your Student Website: IBIS Industry Risk Ratings

ARE WE GETTING LOOSE (AGAIN)?“Some of the loans we see banks making today are going to customers who almost certainly would not have qualified for the same loan 4 to 5 years ago.”

• Thomas J. CurryComptroller of the CurrencyRMA Risk Management Conference (11/2015)

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ARE WE GETTING LOOSE (AGAIN)?“We still see competition driving underwriting standards [downward]. We still see relaxed covenants.”

• Darren BenhartDeputy Comptroller of the CurrencyRMA Risk Management Conference (11/2016)

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TRUE LOAN PORTFOLIO RISK MANAGEMENT

A profound shift...From Reactionary: Managing Credit Risk Upon Discovery

To Proactive: Scenario Testing & Incorporate Capital Planning

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FIRE! ANALOGY

1. Where is the risk of fire? Identify Early

2. What would a fire do to the bank? Expected Loss (EL)

3. How likely is a fire to happen? Probability of Default (PD)

4. Are we doing things to increase the risk of fire?Re-evaluate: CRM/ERM, Credit Policy (Exceptions), Loan Review

5. What needs to take place to help prevent a fire?Refine: Risk Culture, Policies/Procedures

6. What do we need to put the fire out? Capital Planning, Manage Underlying Causes

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A DIFFERENT PERSPECTIVETraditional Credit

Risk Mgmt.Loan Portfolio

Risk Mgmt.Scope Product Type One PortfolioIncentive Loan Volume Economic Profit

Philosophy Originate & Hold Underwrite & Distribute Risk

Evaluate Transaction, Customer

Loan Segments, Co-variance of

RiskPricing By Product Type Risk-based

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LOSS EMERGENCE TIME LINEForward-Looking

• Change in Demand• Economic Cycles• Decline in Sources of Income

Loss Event• Loss of Major Customer• Job Losses• Property Values Decline

Discovery• Financial Statement Monitoring• Covenant Violation• Delinquency

Response/Outcome

• Risk Rating Criticism• Work-out• Charge-off

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HOW TO STEP-UP YOUR BANK’S LPM

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MATTERS REQUIRING BOARD ATTENTION

0%

10%

20%

30%

40%

50%

60%

2011 2012 2013 2014 2015

Percent of Satisfactorily-rated Exams with MRBA’s

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Source: FDIC Supervisory Insights (Summer, 2016)

MATTERS REQUIRING BOARD ATTENTION

0%

10%

20%

30%

40%

50%

60%

70%

Credit Admin ProblemAssets

ALLL Concentrations IndependentReview

Lending-related MRBA’s by Topic

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Exams conducted during 2014-15.Source: FDIC Supervisory Insights (Summer, 2016)

ROOT LPM IN YOUR BANK’S CREDIT CULTURE

Risk Culture

Policy & Procedures

Loan Portfolio Management

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STRENGTHEN YOUR 3 LINES OF DEFENSE1. Business Unit

• Individual accountability and responsibility for actions and decisions? Consequences?

• Are bank objectives weighed more than individual or profit center goals?

• Do we truly take the time to instill our values?

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“Conduct Risk” - $321B in fines issued globally.

-- Boston Consulting Group (March, 2017)

3 LINES OF DEFENSE2. Management

• Board governance• CCO should not be alone to enforce discipline• A culture of “Everyone is responsible for risk.”• Establishment of CRO or risk committees (board or

management levels)

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EXAMPLE: A MORE GRANULAR RISK RATING MATRIX

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3 LINES OF DEFENSE3. Loan Review

• Models are no substitute for hands-on review • Traditionally aligned with (external) audit• Current trend to align with risk management

• Reviewer’s skill sets and experience; outsource benefits• More proactive with Business Unit:

• Economic & competitive industry drivers• Loan underwriting (collateral monitoring & covenants)• Pre-closing (documentation, approval terms)• Post-closing• Periodic (annual) reviews

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FILE REVIEW VS. LOAN REVIEWFile Review

• Compliance with approval terms & credit policy• Financials, DSCR, LTV

Loan Review (risk identification)Cash Flow analysisCollateral valuation Loan structure & documentation Industry trends Identify training needs

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LOAN REVIEW VALUE ADDSBehavior alignment with credit policy, stated risk appetiteApproving authority structure

• Checks and balances, Incentive plan basis• Individual lender tendencies

Risk Rating accuracyPolicy & Underwriting Exception managementLoan monitoring commensurate with risk trendsAdequacy of ALLL

On your Student Website: Top 10 Characteristics of a successful Loan Review function

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EXCEPTION TRACKING(4 KEY AREAS)

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Risk Ratings

Technical Exceptions

Underwriting Exceptions

Policy Exceptions

EXCEPTION TRACKING

Risk Ratings• Individual loans (material borrower changes vs. bank errors)• “Double-dips”• Aggregate Risk Ratings

• By loan segment• Direction• Overall accuracy

Technical Exceptions• Financials not received per approval• Documentation shortfalls (e.g. missing info, signatures)• Covenant violation without acknowledgment/waiver

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EXCEPTION TRACKINGPolicy Exceptions

• Compliance with policy & regulations• Guaranty coverage• Outside market• Concentration limit exceeded• Approval authority

Underwriting Exceptions• DSCR, DTI guidelines exceeded• Collateral documentation issues• Inspections do not meet approval requirements• Loan term exceeds guideline• LTV exceeds guideline• Weak quality or timing of financial information• Unsecured lending guidelines not met

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CONCENTRATIONS CAN KILLCorrelated credit exposure

• Borrowers• Industries (co-variance)

• Supply chain risk (interest rates: developers, homebuilders)• Common factor risk (fuel cost: trucking, ag production)

• Product Type (first mortgages, HELOC’s)Community (smaller) banks are inherently less diversified than large banksRegulatory Guidance:

• OCC Semi-annual Risk Perspectives

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CONCENTRATION EXAMPLE: MULTIFAMILY

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MANAGING CONCENTRATIONSRisk Appetite Statement [Policy]

• Board-driven (top-down support)• Goal: To ensure aggregate risks do not exceed the bank’s

risk capacity (capital base)• Separate Statement or made part of Credit Policy• Need to define:

• Geography – primary and secondary market territories • Industry or sector [first 2-digits of NAICS codes]• Roles & responsibilities of management, lenders, staff• Report types & frequency

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MANAGING CONCENTRATIONS• Concentration Reporting

• Graphs/Output are NOT the sole focus of managing concentrations

• Longer-term trends• Notable recent developments• Peer comparisons, if available

• Macro-economic Correlation• Chart loss history of industry/loan type with changes in GDP,

local unemployment, housing starts, or business conditions surveys, such as:

• Creighton University’s Economic Outlook (business.creighton.edu/economicoutlook/)

• Aruoba-Diebold-Scotti Business Conditions Index (philadelphiafed.org)

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Source: Philadelphia FRB website

MANAGING CONCENTRATIONSSetting Concentration Limits

• Individual Borrower (including related entities)• Loan Type• Collateral Type (CRE property types)• Geography• Bank’s house limit (< legal lending limit)

• Exceeding the 100% or 300% CRE thresholds:• triggers for robust risk management & regulatory scrutiny.

• Approvals required revise/exceed Concentration Limits.

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MANAGING CONCENTRATIONSConcentration Management Strategies for:• Organic Growth

• Address existing concentrations when prospecting• Discourage additional lending in over-limit areas

• Communicate credit expectations• Tighten credit quality standards• Inherent risk in just increasing loan pricing

• Purchased Loan Participations• Evaluate in-house expertise• Lead bank’s culture, covenants, and monitoring• Background checks on borrowers/principals

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STRESS TESTING• Identify triggers or key variables for potential losses

• Develop Scenarios and Test impact on DSCR & LTV• Combine data variables for scenarios—some examples:

• C&I = DSCR and LTV• CRE = Occupancy (Vacancy), NOI, Cap Rate and LTV• Consumer = Credit Bureau Score and LTV

• Assess bank’s vulnerability to downside scenarios, using:• Market (Economic) Analysis

• Correspondent Bank• Follow favorite Economists• American Bankers Association

• External sources of information• Local/state government, industry trade magazines• Real estate transactions, taxable sales data

• Google News – Specific Industry info • Personalize Google News for your Bank

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STRESS TESTING

• Using Stress Testing to Test Capital Adequacy • Vulnerability x Likelihood = potential Qualitative Factor in

ALLL• Historical relationship between changes in Non-accruals

and Charge-offs (time lag)• What happens to ability to make Provisions with step

increases in Non-Accruals?• Shift in underwriting strategy and expected effect on loan

volume• Effect of losing or failure of a major customer

relationship(s)

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HOW TO GET THE MOST OUT OF YOUR LPM*Minimum [Traditional] LPM Reports:• Portfolio Composition

• Borrower (related) relationships• Call Report categories; Industries; Geography; Loan types

• Portfolio Risk• Risk Ratings• Large Loans• Policy Exceptions

• Portfolio Quality• Delinquencies (new, migration), Non-performing Loans• DSCR, DTI, LTV, Monitoring Defaults

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*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

HOW TO GET THE MOST OUT OF YOUR LPM*Minimum Types of LPM Reports to include:• Loan Officer Assessments

• Addresses portfolio management (e.g. past dues, monitoring exceptions, maturity extensions, etc.)

• Ideally additionally addresses key drivers for incentive plans (e.g. portfolio profitability, loss rates, etc.)

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*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

HOW TO GET THE MOST OUT OF YOUR LPM*Avoid These Pitfalls:• Focusing on outcomes, not causes

• Portfolio quality ratios reflect results of past lending decisions (possibly 3-5 years ago).

• Mergers & acquisitions’ affect on portfolio mix and dynamics

• Failure to adapt• Not growing the portfolio monitoring with the growth of the

bank• Specialized lending (e.g. residential construction, trucking,

hotel/motel) require different key variables to track.

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*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

HOW TO GET THE MOST OUT OF YOUR LPM*Avoid These Pitfalls (continued):• Present Snapshot only

• Limited focus, lacking perspective (historical comparisons)• Numbers without Analyzing

• Lots of graphs, tables and data…but no:• Interpretation of results• Discussion of trends• Recommendations

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*Source: Barrickman, John and Stein, Gary, RMA Journal (July-August, 2005)

MONITORING PORTFOLIO PERFORMANCE• Typical LPM Key Metrics:

• Past Dues / Total Loans & Leases

• Non-Performing Loans** / Total Loans & Leases• Non-Performing Loans / ALLL• Non-Performing Loans / Capital & Reserves [Tier 1 + ALLL]

• Classified Loans / Total Loans & Leases (+ OREO)• Classified Loans / Capital & Reserves

• Net Charge-offs / Total Loans & Leases• ALLL Provisions / Net Charge-offs

**Total loans and leases > 90-days past due + non-accrual loans and leases + other real estate owned [OREO]

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MONITORING PORTFOLIO PERFORMANCESample Scorecard

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2016Goal Very Good Satisfactory

Needs Improvement Unsatisfactory 12/31/2013 12/31/2014 12/31/2015 Trend

Past Dues / Total Loans & Leases < 1.00% < 0.75% 1.50% 2.00% 3.00% 1.75% 1.32% 1.02%

NPL / Total Loans & Leases < 1.00% < 0.25% 0.75% 1.50% 2.50% 1.30% 1.10% 0.88%

NPL / ALLL < 20.00% 20.00% 40.00% 60.00% 80.00% 42.00% 26.00% 19.00%

NPL / Capital & Reserves < 30.00% 25.00% 40.00% 50.00% 60.00% 29.00% 16.00% 9.00%

Key Credit Risk Portfolio Metrics Actual Results

USE LEADING INDICATORS1. Use Vintage in Reporting

• Example: Past Dues by Loan Type and Number of Months since Origination (not calendar year/quarter)

• Apply to upcoming marketing blitzes or loan ‘specials’• Compare with changes made in underwriting (policy &

procedures)2. Line of Credit Utilization

• Individual Customer and/or Industry Concentration• Compare with other Customers in same Industry• Unsecured Loan utilization (percent of outstandings)

3. Upgrade (Downgrade) Activity – with specific reasons• Risk Ratings • Non-Accruals

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USE LEADING INDICATORS4. Review New Loan Applications

• Approval & Declination Volume & Trends• Reasons for Turn-downs• Average Credit Bureau (FICO) scores on approved and

declined• Trends in types of requests or inquiries

5. Review Sales Calls• Credit-worthiness of Prospects• Reasons for not obtaining their business• Lenders gravitating to ‘lower-hanging fruit’ when lagging

in production

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USE LEADING INDICATORS6. Peer Group Comparisons

• Custom Peer Group (similar portfolio mix, demographics)• Volume changes in Loan Types (Call Report segments)• Charge-off history during good/bad economic times.

7. Learn from Others• Spilled Milk articles• FDIC: Material Loss Reviews

• Reasons for failed institutions• OCC: Semi-annual Risk Perspectives• Networking & Risk Management Conferences

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LPM: A CONTINUAL PROCESS

Credit Culture

Policy & Procedures

Assess Risk

Report Exceptions

Manage Risk

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TRUE LOAN PORTFOLIO RISK MANAGEMENT

A profound and difficult shift...From: Managing Credit Risk Upon DiscoveryTo: Scenario Testing & Capital Planning

“It’s not too late to start, but it’s later than you think.”

-Mike Wear(an old Credit Guy)

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THANK YOU

ADDITIONAL MATERIAL PROVIDED – SEE STUDENT WEBSITE

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