Act Now to Protect Yourself and Your Institution
It’s Not Too Late!
by Don Lowenstein, President and founder, Lowenstein and Associates, PC.
Everyone is at risk. Directors, executives, investors, employees, customers and members are all in this together.
Your loan portfolio is most likely the largest asset in your institution. Don’t take chances using obsolete loan review and ALLL reserve calculation procedures.
We are currently facing the worst economic meltdown since the great depression. Congress has passed the bailout (rescue) bill, but no one is sure how those funds will be used or when and to whom they will be disbursed.
You are affected in many ways, whether your institution practices conservative lending or not. Already, credit policies are tightening and the pool of qualified borrowers is shrinking.
Government intervention and regulation are sure to increase:
· Your institution can expect more intense examination review of underwriting policies and the experience of your lending staff.
· Reviews will also scrutinize delinquency patterns within loan pools, capitalization adequacy and sufficiency of loan reserves.
· The increased regulation will affect all types of credits including commercial, mortgage and consumer. No type of lending will be exempt.
There is a lot at stake for every financial institution.
· Many have failed since the beginning of 2008, with many more failures expected.
· Examiners will insist on well documented lending policies and procedures with strict adherence to those policies, and an assessment of your current financial stability.
· Initially, regulations will focus more on reactive than proactive initiatives in an effort to stabilize the lending environment.
We can expect many reductions in CAMELS ratings as regulatory scrutiny becomes more intense. But, stabilization is not enough. Proactive procedures are needed more than ever before.
For starters, it is imperative that you beef up your loan review program. Reserve estimates that are based solely on historical losses and current delinquencies are no longer acceptable. Review of every borrower and their ability to repay loans is absolutely required. Proactive reviews must consider the economic, geographical, political and international trends that affect the quality of each credit. In accordance with FASB 114, individual loan review must become the norm. 100% review – nothing less.
Next, constant assessment of the underlying data is critical. FASB 157 states that objective and reliable data must be used when determining fair market value of a credit. Appraisals, collateral valuations, credit scores and other underlying data used in the loan review must be provided by independent and reliable external sources when available. Asset valuations based on five year old appraisals or credit scores is simply not accurate in today’s climate. Much of this data can be easily acquired from independent sources and must be used in your loan review program. Examiners won’t find it acceptable if you ignore this. Focus on reliable, current and complete data within your loan review program is essential. This results in ALLL calculations that reflect reality and eliminate surprises.
Lastly, you must conduct regular stress testing of your loan portfolio. Vary as many assumptions as feasibly possible. Utilize tools that make stress test processing an easy task. That way, your time can be spent identifying likely quantitative and qualitative scenarios which may directly affect the quality of your loan portfolio. Modifying the assumptions and “what-if” scenarios should be simple and easy to extrapolate across your entire portfolio. Be sure to establish mild, moderate and extreme stress benchmarks that are applied consistently and objectively, on a routine basis.
There is too much at stake today. Be proactive and use a combination of technology and good old common sense. Get your arms around the true value of your portfolio immediately. Look at every loan every month using consistent and objective review criteria against accurate and current data. Also, be proactive by performing extensive portfolio stress testing on a regular basis. If you know the exact value of what you loaned yesterday, and consider potential risks that may affect your portfolio value tomorrow, you can make better lending decisions today.
This problem crosses all institution demographics and sizes. We’ve seen failures from fifty million to multi-billion dollar institutions. None seem immune. And, the problem is not only in the United States. There appears to be a worldwide connection to this economic meltdown.
To make matters worse, when defaults occur and foreclosure seems eminent, problems are worsened because of declining collateral and appraisal values.
About the Author
Don Lowenstein is the founder and president of Lowenstein and Associates, PC and a Certified Public Accountant. Don began his career at a Big Eight accounting firm in Chicago, Illinois. In 1985, he moved to Missouri and developed his first software application, a fully interfaced loan origination system. Since then, Don has provided consulting services and specialized software solutions for loan review, construction loan operations, cross system interfacing engines and charged-off loan tracking to hundreds of lenders throughout the United States. Don still works directly with clients and oversees company operations. He is a frequent speaker at industry events.