Depending on what publication you read, 2024 could mark the start of the downturn in credit quality, but financial reports for community-based institutions are not yet showing that to be a consistent, widespread trend. As is always the case, an effective credit-risk review function is critical to safe and sound operations because it helps financial institutions identify, evaluate, and address emerging risks associated with credit weaknesses, as well as validate or adjust risk ratings to provide for negative trends.
CRE Lending
One of the areas that is a significant area of focus is commercial real estate (CRE) property types, which remained resilient in 2023. While the markets for new office and retail malls has declined, the financial institution industry remained active in CRE lending in 2023, and CRE loan exposure remained elevated in many areas and institutions.
The amount of CRE loans scheduled to mature through 2026 remains elevated, while the ability for such borrowers to refinance is becoming more challenging with higher interest rates and the softening property values with certain markets. As history has shown, credit stress has always followed economic, political, or financial uncertainty and the coming year could start to show the impacts of those factors.
- independence from internal lending and approval functions
- expertise of the loan review team
- supportable loan review conclusions
- the quality of the entire process
Loan Review best practices. A strong loan review function can be accomplished with an in-house team, an outsourced third-party expert, or a combination of the two. While regulators don’t prescribe one approach over another, the factors most important to them are independent from internal lending and approval functions, expertise of the loan review team, supportable loan review conclusions and ultimately the quality of the entire process.
Use highly experienced credit review experts. Assemble a team of qualified personnel with extensive experience in commercial and consumer lending products, credit analysis, institutional loan policies, state and federal regulations, determining reserves, and managing problem loans. Ensure they have the appropriate training and tools to properly analyze financial information, including simple areas such as reading and understanding a borrower’s financial statements. Make sure these individuals are part of the loan policy review process to identify potential weaknesses or revisions that may be necessary as the credit environment changes.
Focus on the data available and understand that it may be limited. Regulatory guidance notes that loan files with missing, stale, and improperly executed documents (document exceptions), credit downgrades, especially when viewed in the aggregate. Individuals with appropriate experience should analyze document exception patterns to identify steps in the process, business lines or geographic regions where exceptions occur, and will need additional monitoring. Using stale dated information for assessing the strength of the portfolio may lead to decisions about expected credit losses that may no longer be supportable.
Identify hotspots. When the broader loan portfolio is analyzed, identification of risk issues that could turn into future problems can be detected and remedied timely to reduce losses. Start with an evaluation and rating of individual relationships, each credit facility, or both relationships and facilities. Your institution’s loan policy should designate who is accountable for ensuring ongoing monitoring of loan quality. Often, it is the account officer’s responsibility because they know (or should know) more about the borrower than anyone else and should be able to secure timely financial information. Ensure that they are asking for and receiving information from borrowers on what they are expecting for the remainder of the year, including cancelled projects or leases that could significantly impact cash flow.
Rethink your approach. Traditional credit risk methods do not typically allow for real-time updates on a borrower’s financial situation, leaving the institution vulnerable to negative changes. Automating credit risk management processes may help an institution make informed decisions about extending credit to customers, mitigating risk, and improving cash flow. Continue to evaluate available products or systems that will make information available timelier for evaluation.
Rely on Rehmann as your credit review partner for real-time credit portfolio analysis to identify weaknesses and propose solutions to help.
Contact [email protected] or call 616.975.2855
