Risk Ratings and Restructuring

COVID-19 continues to evolve with unimaginable ramifications to individuals and businesses around the world.  The outbreak has caused increasing global business and economic disruptions.  The spread of this disease and its resulting economic impact is unprecedented.

Most certainly loan portfolios have been both directly and indirectly impacted with increasing risk based on the current impact of COVID-19.  Programs such as PPP, EIDL and the various forms of loan modifications and payment deferrals have provided either some level of working capital or cash flow relief to many borrowers.  These programs may keep borrower’s from going into default in the near term.  Unfortunately, COVID-19 is currently too unpredictable, and these conditions may persist for some time.

Employment levels may be one key factor to help risk managers appreciate the potential impact of COVID-19.  The result of legislative actions has triggered an unparalleled and extraordinary rise in unemployment.     The March 23, 2020 “On the Economy Blog” titled Back-of-the-Envelope Estimates of Next Quarter’s Unemployment Rate, by Miguel Faria-e-Castro, Economist, provides some insights into the potential outcomes for unemployment for the 2nd quarter of 2020.  The paper identifies 66.8 million people that are employed in occupations that are at high risk of layoff and  another group of 27.3 million workers with occupations identified as high personal contact intensity.  Through these two groups, the author estimates a potential unemployment rate of 32.1% in the second quarter of 2020.  This includes an estimated 47.05 million people laid-off during the second quarter plus the existing 5.76 million existing unemployed.

These numbers are staggering and truly hard to imagine. Unemployment will continue to be impacted by the speed and depth of state’s restrictions on non-essential jobs.  However as recent as April 9, 2020 economists were still anticipating an unemployment rate of 25%.  To put this into context, the unemployment rate peaked at 10% during the Great Recession.

The Five C’s of Credit include Character, Capacity, Capital, Collateral and Conditions.  Currently, the C in Conditions is heavily influenced by the other new C, the C in COVID-19.  Conditions not only include interest rate, loan amount and repayment terms, but also include factors outside of the borrower’s direct control such as the state of the economy, industry trends or pending legislative changes.  Conditions outside of the borrower’s control have had an immediate outsized impact on borrowers.  In addition, current Conditions have significantly influenced three of the remaining 4 C’s of Credit: Capacity, Capital and Collateral in various ways and to various degrees.  Conditions may also provide a greater insight into the Character of borrowers.

Bank regulatory agencies (agencies) have communicated they, “will not criticize institutions for working with borrowers in a safe and sound manner”.  Additionally, the Financial Accounting Standards Board (FASB) in coordination with the agencies has indicated payment modifications under Section 4013 of the CARES Act will not constitute a Troubled Debt Restructure (TDR) under ASC 310-40.  FASB specifically excluded government-mandated modification or deferral programs related to COVID-19.  The non-inclusion of modifications under the CARES Act provides bankers an opportunity to work with borrower’s without immediately impacting Call Report requirements.  The non-inclusion of TDR requirements for Call Reporting purposes does not mean risk has not increased within the loan portfolio.  It should be clear a determination of TDR status and risk ratings remain two separate decisions.

The current economic downturn was not anticipated in terms of both the timing and the broad nature of the impact.  Risk in loan portfolios has increased and continues to increase each day we are restricted from our conventional business operations.  A great deal of uncertainty remains regarding the length, severity of the impact of COVID-19 along with the shape of the subsequent recovery.  Loan portfolio risk identification and management should continue to be fluid and best represent the current risk in the loan portfolio.  Regulators will continue to expect appropriate risk identification within the loan portfolio.

Risk ratings should be accurate and timely with a dynamic approach for ratings to change as the risk changes.  Risk rating methodologies should provide for early identification of problem credits, form the basis for the ALLL and provide for loan portfolio management.  Bankers will need to continue to appropriately monitor and adjust risk ratings on a case-by-case basis to provide a timely assessment of risk within the loan portfolio.

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Time to incorporate a remote loan file review?

This blog was initially posted in January 2019. Presently the coronavirus is creating the need to minimize unnecessary contact and create appropriate social distance. Financial institutions have begun to implement reduced branch access and other measures to limit personal physical contact. Unfortunately, we are also beginning to experience the economic impact of the virus as many businesses are no longer able to provide the product or service in their traditional way. Financial institutions will need to continue third-party provided audit services. We believe loan review is a service that can be remotely delivered and provided for continued portfolio risk management. Integrity Loan Review is ready to assist you with a remote loan review for your organization.

Third-party independent loan review is a staple of loan portfolio risk management for many community-based financial institutions.  Traditionally, loan reviews were performed on-site at the financial institution to provide access to both the files and staff. This traditional approach is changing as regulatory agencies are now driving more procedures of their field work that can be completed remotely and as more financial institutions are better leveraging the continuing improvements in imaging technology and data security.  This combination can provide for greater opportunities for remote loan reviews.

Most of our current loan reviews involve an imaged-based or other electronic file system.  Although the credit file information is electronic, many of the loan reviews we perform remain on-site.   In theory, there are few reasons these on-site reviews should remain as an on-site review.  We are, however, beginning to see an increasing trend toward remote loan file reviews.

The Federal Reserve’s Commercial Bank Examination Manual, October 2018 (Supplement 45 -April 2016, section 2088.1) provides for the inclusion of remote loan file reviews as part of their examination procedure for community banks.

The Federal Reserve may use the off-site loan review program when leading examinations of State Member Banks with less than $50 Billion in assets and where the Bank has communicated its’ willingness to participate in a remote loan review program.

The Reserve Bank will consider the following when determining whether an off-site review of loan files is appropriate for an institution:

  • Will the institution submit the loan file data using a secure transmission method such as cloud-based collaboration products, secure email services, encrypted removable media, virtual private networks, or remote desktop control services?
  • Up-front technical preparation is necessary to ensure the data is made available in a secure method, typically a VPN, secure portal or other secure options.
  • Is the institution able to provide loan data and imaged loan documents that are legible, easily viewable, and properly organized to allow for timely review by examiners?
  • Image quality must be sufficient for easy reading with images sorted and labeled in a consistent method to allow for accurate searches.
  • Are the loan files comprehensive to allow an examiner to conclude an appropriate rating of a credit without having to request additional information from the institution?

This criterion works well to determine if a third-party remote loan review would be an opportunity for your financial institution.  This determination may involve input from the institution’s information technology department along with their credit administration to determine the institution’s capability to both deliver complete loan files along with the quality and current condition of the credit files.

Financial institutions should consider the many reasons a remote loan file review can be a part of their approach to third-party loan reviews.  The remote loan review process can:

  • be more efficient by minimizing the day to day disruption for the staff of the financial institution.
  • be less intrusive to the staff of the financial institution by reducing the number of reviewers the institution needs to create on-site space.
  • be more cost effective by reducing travel time and expenses.
  • provide for greater flexibility in the scheduling of the loan file review.
  • provide for a broader geographic selection of qualified loan review firms.

A remote loan review does not reduce the value of the review in assessing asset quality and the credit risk management process of the financial institution.  Key components of a loan review such as the review of credit files for quality, documentation, and compliance with bank policy and laws and regulations can be efficiently and effectively accomplished through a remote loan file review.

Communication throughout the review between the review firm, management and loan officers is key to discuss any findings that may arise in the course of the file review.  Effective communication will also help the reviewer identify any current concerns with the financial institution. Changes to the lending or credit staff, policy or procedures which may create additional risk for the institution, may also be revealed.  The financial institution may prefer to schedule touch points throughout the engagement and a structure exit meeting for the end of the review.

A blended approach to remote loan file review may be a good way to develop the expertise and comfort to achieve for those institutions that are interested but have not yet engaged a remote review.  A blended approach would involve a portion of the review to be completed remotely while a portion of the review would be completed on-site.  A blended approach can still minimize the disruption but allow for face-to-face dialogue as part of the review.  The effective use of technology can be a key tool in minimizing disruption and reducing costs with respect to a third-party loan review.

Kevin Graff is the President of Integrity Loan Review. We have significant experience with numerous imaged and other electronic loan file systems for both remote and on-site loan reviews.  We are happy to discuss with you how a remote review or a blended review can be designed and structured to fit into your loan portfolio risk management needs.  Kevin can be reached at 920-857-6225 or kevin@integrityloanreview.com.

Remote Loan File Review

HVCRE Update – December 2019

On December 13, 2019, the Agencies published the final rule regarding HVCRE (High Volatility Commercial Real Estate) which becomes effective on April 1, 2020. The primary intent of the revision was to create consistency with the statutory definition of HVCRE exposure. The revision will also provide for consistency in the reporting requirements for the Call Report and FR Y-9C.

The update includes a revised definition of HVCRE exposure generally consistent with the usage in other relevant regulations such as the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and the Call Report. The revised rule also removes certain loans from the definition of an HVCRE exposure and therefore reduces the risk weight from 150 percent to 100 percent on some of the HVCRE loans held in portfolio.

HVCRE exposure is defined as:

1. A credit facility secured by land or improved real property, that prior to being reclassified by the depository institution as non-HVCRE exposure pursuant to paragraph (6)1 of this definition.

Loans under this definition are generally further identified under a three-pronged approach

i. Primarily finances, has financed, or refinances the acquisition, development or construction of real property.
ii. Has the purpose of providing financing to acquire, develop or improve such real property into income producing real property; and
iii. Is dependent upon future income or sales proceeds from, or refinancing of, such real property for the repayment of such credit facility;

The revised HVCRE exposure definition differs in primarily two ways:

1. Revised to apply to loans that “primarily” finance ADC (acquisition, development and construction) activities; and
2. The full appraised value of contributed land, less debt, as a part of the project can now count toward the 15% capital contribution.

It should be noted under the revised definition, a credit facility secured by land or improved real property should be interpreted in a manner that is consistent with the current definition of a loan secured by real estate in the Call Report and FR Y-9C instructions. This includes loans that are “primarily” (50% or more) secured by real estate.

Further clarifications include an exemption from HVCRE exposure for loans that finance 1-4 family residential structures. The HVCRE definition of 1-4 family loans is now aligned with the Call Report and FR Y-9C definition. The revised definition does not exempt loans provided primarily to finance land development activities for 1-4 family projects. Additionally, the revision clarifies condo and cooperative construction loans will qualify for the exclusion from HVCRE treatment. The exclusion is applied even if the loan is financing the construction of a building with 5 or more dwelling units if the repayment of the loan comes from the sale of individual condo or coop housing units.

Financial institutions may continue to apply the current methodology to the identification and accounting for HVCRE property until April 1, 2020. Institutions are permitted, but not required, to reclassify HVCRE loans that they currently hold to take advantage of the lower risk weight. If a loan is presently an HVCRE exposure, the loan will remain an HVCRE exposure until reclassified by the banking organization as a non-HVCRE exposure. After April 1, 2020, new loans that would have been classified as HVCRE but for this rule would receive a 100 percent risk weight instead of a 150 percent risk weight.

The FDIC estimates the rule is likely to affect a substantial number of small, FDIC supervised institutions reducing the risk weight from 150 percent to 100 percent on some of the HVCRE loans held in the portfolio. Although the number of small institutions impacted will be great, the FDIC does anticipate a
relatively small (less than 5%) reduction in risk-based capital.

Acquisition, construction and development loans generally have a greater risk profile comparatively with other types of traditional lending. The revised HVCRE exposure definition is an effort to capture those ADC loans that have increased risk characteristics. The revisions, while not a wholesale change, are
important and meaningful for an institution to understand and adopt. These changes were driven by Section 214 of EGRRCPA which added section 51 to the Federal Deposit Insurance Act. Section 51 provides a statutory definition of HVCRE ADC loans. These changes will provide for further clarity in the
identification of HVCRE and the consistency in reporting between depository institutions and holding companies.

For a printable copy of this post, please click here.

For the full definition and criteria for HVCRE exposure, please see Federal Register, Vol. 84, No. 240, Friday, December 13, 2019. https://www.govinfo.gov/content/pkg/FR-2019-12-13/pdf/2019-26544.pdf

Happy Thanksgiving from your friends at Integrity Loan Review!

We Thank Thee

For flowers that bloom about our feet;
For tender grass, so fresh, so sweet;
For song of bird, and hum of bee;
For all things fair we hear or see,
Father in heaven, we thank Thee.
For blue of stream and blue of sky;
For pleasant shade of branches high;
For fragrant air and cooling breeze;
For beauty of the blooming trees,
Father in heaven, we thank Thee.

– Ralph Waldo Emerson

RMA – Wisconsin Chapter

The RMA Wisconsin Chapter began its’ new fiscal year as of September 1, 2019.  At that time, I became the new President for the RMA Wisconsin Chapter.  I am honored to take on this role to continue my service on the board and give back to the banking community.  I joined the RMA Wisconsin Chapter board of directors in 2012.  The Chapter has experienced amazing growth during that time offering a greater number of educational classes, roundtable discussions and other industry social and educational events throughout the state.  These events are not only designed to provide training for bankers but to also provide a networking format for bankers to get to know their peers.

I take over as President at a thriving time in the RMA Wisconsin chapter history.  The RMA Wisconsin Chapter has earned the RMA National Platinum award four years in a row.  This is the highest-level award a chapter can receive within RMA.  The Wisconsin Chapter provides programming to strengthen the banking community within the state we live and work.  A stronger banking community benefits everyone.  This includes individual bankers as they are better prepared to succeed in their banking careers.  Employers can rely on RMA for thorough risk management training.  Consumers of banking services also benefit from bankers that are better equipped to service their needs. Banking is the lifeblood of communities and a strong banking network enhances the vitality of these communities.

We are a volunteer board with all members having specific responsibilities to help the chapter achieve its goals.  We welcome others who are passionate about the industry and are looking for a way to be involved and give back to the banking community.  I look forward to the future of the Wisconsin RMA Chapter as we continue to provide events and opportunities designed to enhance learning and networking while building the success of the banking community.

We welcome those who are interested in being involved with a vibrant organization.  If you are interested in learning more about RMA and the opportunities to share your knowledge, experience and time, please contact me at kevin@integrityloanreview.com.

On a professional note, I remain active in the industry through my company, Integrity Loan Review. I founded Integrity in October 2018 to remain focused and committed to community based financial institutions. Integrity Loan Review, LLC is a full-service loan review provider. Integrity’s methodology is straightforward yet customized to your needs to make the best use of your time and risk management dollars. Our goal is to provide exceptional, timely service and valuable advice at competitive rates.

Kevin Graff is the President of Integrity Loan Review. He has significant experience with loan review and credit administration. He enjoys discussing how RMA can benefit you and your organization. Kevin can be reached at 920-857-6225 or kevin@integrityloanreview.com


To download a printable pdf of this document, click here.

Institutional Knowledge

New financial calculator:   $50.00

Box of pencils:   $5.00

CECL software program:   $15,000

Institutional Knowledge:   PRICELESS 

Community based financial institutions are a tremendous asset to the areas they serve. Typically, the financial institution is a pillar of the community through the volunteer hours of the staff, financial contributions to local organizations and professional expertise. Business bankers in these communities work closely with their customers to understand their financial needs and help them plan for a successful future. Many times, the banker and business owner have additional shared interests within the community that furthers the professional and personal relationship. 

The knowledge gained in working with business owners in various contexts provides a further understanding of the individual and their business. This knowledge can be very instrumental in how a financial institution chooses to provide additional services and credit to a customer. 

This information that is compiled within individuals over time is known as institutional knowledge. Institutional knowledge can be defined as “the combination of experiences, processes, data, expertise, values, and information possessed by company employees. It can span decades and comprise crucial trends, projects, perspectives and that define a company’s history.”1 

This information is often difficult to quantify but can be significant when considering a credit request. Impromptu conversations take place during Little League games or after Sunday service. Real information regarding the business and business owner is gleaned in these conversations and adds to the banker’s knowledge and understanding of the business. Over time, a significant amount of information is gained in both scheduled and unscheduled conversations with the business owner. This understanding of the business owner and their business makes the banker an even greater asset to the financial institution as they retain and further develop these relationships. 

These relationships also come with their challenges, as many times customer files are not updated with formal or informal call notes. CRM systems which capture call notes are either not in place or may be inconsistent in their use. Key information regarding a business borrowing relationship may only exist in the mind of the banker who had the conversation. Although many times a secondary contact has a certain level of familiarity with the business borrower, a lack of documented call notes and a memorialized history of the relationship can place the financial institution at additional risk should the banker no longer be employed with the institution. 

Credit requests/presentations sometimes provide limited insight into the nature of the business, key changes within the business, and the near-term outlook for the business. This limited information is not for a lack of knowledge regarding the borrower. Generally, it is quite the contrary. The banker, the loan committee or the board of directors have such a knowledge regarding the borrower, that fundamental information regarding the borrower and their business is overlooked in the credit presentation. It is assumed everyone is familiar with the relationship. As a result, credit presentations suffer and do not accurately reflect the financial institution’s knowledge and understanding of the borrower. 

A credit presentation is an important tool in the credit process to capture the relevant data and institutional knowledge regarding the borrower and their financial needs. The credit presentation is also a reflection on the overall financial institution and their credit culture. 

My friend and colleague, Gary Maples of Riveredge Consulting, LLC, has developed a course for the Wisconsin Chapter of RMA titled, “Essential Elements of a Credit Presentation.” In this course, Gary teaches the objectives a credit presentation serves within a financial institution. The course includes a high-level summary of the purpose of credit presentations. They include: 

  • Credit presentations are for many audiences and several purposes 
  • Credit presentations are not just for the relationship manager 
  • A major purpose of a credit presentation is to inform those who have the least knowledge of the borrowing relationship and its risk. 
  • A poor-quality credit presentation is often indicative of poor-quality credit risk administration. 

Institutional knowledge of credit relationships is priceless and difficult to fully memorialize. Underwriting software programs have improved the ease of use to carry information forward from prior presentations to make updating the data more efficient. Credit presentations should include sufficient information regarding the borrower and the credit request, (based on the size, complexity and risk rating of the relationship) to meet the needs of the various stakeholders, examiners and auditors Complete credit presentations can further minimize risk to a financial institution as key information is; captured, presented and discussed at the appropriate levels. 

Finally, on a lighter note, as the NFL season is just around the corner, the following is a hyperlink for a Brett Favre Mastercard Priceless commercial. https://www.youtube.com/watch?v=ZoEGYFzS0jA 

Kevin Graff is the President of Integrity Loan Review. He has significant experience with loan review and credit administration. Kevin can be reached at 920-857-6225 or kevin@integrityloanreview.com

To download a PDF of this post, please click here.

1 Institutional Knowledge: What It Is & How to Use It, Kristen Craft, May 3, 2019

Mountain Biking and Portfolio Management

Mountain Biking and Loan Portfolio Management

This September will be the 37th running of the Chequamegon Fat Tire 40, an annual mountain bike race between Hayward and Cable, WI. Entrants consist of both the competitive set and avid riders who consider this sort of thing fun.

I began mountain biking in college when mountain biking was considered a fringe sport. The sport includes the challenge of technical trails and time riding in the woods, which I have continued to enjoy. I have had my share of bumps and bruises (to both my pride and my body) over the years resulting from this sport.

I have participated in the Fat Tire 40 on three occasions with the most recent approximately five years ago. The ride created many fond memories. It is both the most fun I have had in an organized event yet the most challenging, both mentally and physically.

I have some neighborhood friends who also like to mountain bike. We get out on occasion to hit the local trails and enjoy this sport with all its inherent risks, especially for us old guys. I was able to convince these buddies to enter this race with me for the fall of 2019. They are a little freaked out at the thought of this ride. An event like this will require a commitment to deliberate planning and execution. The execution of this plan will build mental and physical endurance, an opportunity to achieve a successful outcome and have some fun along the way.

The event will also include many risks to the riders. There is a risk of serious injury, a risk of mechanical failure, a risk of physical and mental limitations, a risk of poor weather and riding conditions to name just a few. A prepared rider can mitigate these risks. Equipment such as a helmet and other protective gear may minimize the risk of serious injury. A small tool kit, spare tube and CO2 cartridge may assist with any bike issues. Nutrition and hydration along the ride will ensure enough calories and fluid to allow the body to perform. Finally, appropriate gear may help mitigate the risks of poor weather and riding conditions.

A study of the course map will also be critical in executing the event. The Seeley Fire Hill at mile 28 creates many walkers amongst the riders. Knowing and anticipating sections of the course will help us prepare mentally to know the tougher spots of the ride.

Similarly, planning and execution of loan portfolio management is critical to the success of a financial institution. Loan portfolio management includes the steps taken to identify and control risk throughout the credit process. Portfolio management does not include an end-point like the finish line in the Chequamegon. Portfolio management can include methods to measure performance and the success of a loan portfolio management plan. Management can also incorporate tools to look ahead to anticipate bumps in the road.

Many risks are assumed in the lending process, much like mountain biking. A sound loan portfolio management policy will identify the riskier areas of the loan portfolio and incorporate appropriate monitoring techniques. Riding further on a trail will identify additional risks to the biker much like further analysis of the loan portfolio can identify current or changing risks. A map of the trail can also help anticipate potential risks ahead. A loan portfolio management plan can serve as the map to consider both internal and external factors that can impact the portfolio today and in the near future.

Financial institutions of all sizes should have a plan and a process for loan portfolio management. These plans may vary based on the size of the institution, the complexity of the portfolio and the types of credit risks assumed. Potential and known risks can be identified in advance in both mountain biking and portfolio management. These items can be addressed early in the process to maintain appropriate risk  tolerance.

Kevin Graff is the President of Integrity Loan Review. He has significant experience with loan review and credit administration. He enjoys discussing how covenant monitoring can become an effective process for your institution. Kevin can be reached at 920-857-6225 or kevin@integrityloanreview.com

Mountain Biking and Portfolio Management

Covenant Monitoring





Loan covenants are an essential part of commercial lending.  They provide a framework of understanding for the borrower to meet the requirements of the lender.  The covenants can include financial reporting requirements, performance-based covenants and operating covenants.  The first two are considered affirmative covenants while the last is generally considered a negative covenant.  The loan covenants are included within the loan agreement as a part of the overall loan documentation.  The specific requirements for the delivery of financial reporting or the testing of loan covenants should be explicitly included in the loan agreement and consistent with the approval of the credit facility.

The identification of the various covenants is one of the key steps in the loan review process.  Our loan review process will generally start with the credit approval document to identify the requirements of the borrower as a part of the credit approval.  We will then review the loan documentation to ensure the covenants are incorporated into the loan agreement or other document per the credit approval.  The next step is to locate the actual financial statements, identify covenant testing has been completed and identify if any operating covenants have been violated. If financial statements are not available or performance covenants are not tested as required under the credit approval, we will note this as an exception and review the institution’s tickler list to ensure the financial institution is tracking the missing items.

While this seems to be a straightforward process, we have had many discussions with our customers regarding performance covenants.  These discussions are generally focused on the timeframe either permitted or expected by the financial institution to complete the testing of the performance covenants, whether it be monthly, quarterly, annually or other.  The question becomes, should the performance covenants be tested upon receipt of financial statements or tested during the annual review process or other credit event.  Unlike a financial reporting requirement, most credit agreements do not include a timeframe for which a covenant should be tested.  Additionally, most loan policies do not identify an expected or required timeframe for the testing of performance covenants.

From here, there are two additional issues for a loan review professional: 1.) what is a reasonable time frame to allow for performance covenant testing and 2.) if the necessary financial statement has not been provided per the credit approval and therefore the covenant is not able to be tested, is the lack of performance covenant testing an exception?

Loan covenants are in place to manage the perceived risk with the credit relationship.  They serve the purpose to monitor the performance of the borrower.  Therefore, we believe performance covenant testing should occur as the required financial statements are received.  A memo or other document should then be added to the credit file to indicate the date of testing, the specific covenants tested and if the borrower passed the required covenants.  Most performance covenants in community banking are tested on an annual basis.  This means year-end financial statements are used to test the covenants.  Many community-based financial institutions rely on the annual review process to update financials and test covenants.  Often, the annual reviews are not closely aligned with the annual financial reporting requirements and therefore weeks or months may pass before the covenant testing occurs.  This potential delay can create incremental risk in the credit relationship should there be a deterioration in the financial performance of the borrower.  Additionally, the significance of the covenant may be eroded if the borrower is notified of a covenant default months after the financial statements have been delivered.

Our loan review position, therefore, is to expect covenant testing to occur and be documented within 30 days of receipt of financial statements.  If not, we generally identify the lack of testing as an exception.  In addition, if a required financial statement has not been received, and as a result a performance covenant is not tested, we would also identify this as an exception.  Two exceptions would then be noted, one for the missing financial statement and one for the performance covenant test.  While it may seem overly critical to identify both as exceptions, the missing financial statement and untested covenant may reflect risk in the relationship and the borrower’s willingness or ability to adhere to the loan covenants.  We do find most financial institutions will include performance covenants on their tickler list, however, we do not often see un-tested covenants on exception lists.  In this prolonged banking cycle, accurate exception lists can identify trends regarding the level and types of exceptions and can be a meaningful tool in the overall loan portfolio management.

There may be a solution to address the timeliness of the testing of the performance covenants.  Most institutions require financial reporting from the borrow and leave the covenant testing to the financial institution’s staff.  This method can lead to significant delays in the testing of the covenants.  An alternative to this dilemma; a covenant compliance certificate requirement.  A covenant compliance certificate could be included as a part of the credit approval and incorporated into the loan agreement.  This is a form submitted by the borrow attesting to the compliance/non-compliance with their covenants.  A standard form or template can be provided to the borrower specific to their covenant requirements to facilitate future reporting.

A compliance certificate will not only expedite the covenant testing process but also further engage the borrower in a clear understanding of their performance expectations by the financial institution and how they are performing against these requirements.  Little additional time may be required by the borrower to complete these certificates on a regular basis as most covenants are formula driven included within a template provided by the financial institution.

We would anticipate compliance certificates to be verified by the financial institution.  This process will not only confirm the result of the covenant test but ensure the borrower is accurately calculating the performance covenant.

Covenant compliance certificates have been a long-standing practice for corporate banking and large financial institutions.  A greater adoption by community based financial institutions may provide for a  more timely and effective covenant management process thereby enhancing the overall risk management process for the institution.

Kevin Graff is the President of Integrity Loan Review. He has significant experience with loan review and credit administration.  He is happy to discuss with you how covenant monitoring can become more effective for your institution.  Kevin can be reached at 920-857-6225 or kevin@integrityloanreview.com

Covenant Monitoring


Loan Policy – A Cultural Evolution

Every financial institution has a culture and more specifically, a credit culture.  This culture can be arrived at in many ways, through the leadership, policies, practices and other intangibles that employees may not even be aware of.  Interestingly, culture is rarely documented as a specific item but rather it is a collaboration of the various policies and procedures and undocumented practices the financial institution has in place to run their business.    It is the culture that sets the tone for how things get done in the financial institution, how customers are treated, how employees are treated and how the financial institution is managed.  It is my experience that separate from their policies and procedures, high performing financial institutions have created a culture where everyone knows what the expectations are, and everyone works to achieve them for the betterment of the financial institution.

The loan policy is a key document that has a substantial impact on the nature of the credit culture.  The loan policy survives the natural turn-over of employees to provide for a consistent approach to credit.  As new employees are added, and more tenured employees leave, long-standing institutional knowledge may disappear.  An evolution of the loan policy may influence a shift in the nature of the credit culture within the organization.  Long understood staples of the credit culture may become less pronounced over time.  Loosening or modifying requirements in a loan policy that may seem subtle at first, may have a broad and profound effect on the credit culture of a financial institution.  I have received direct feedback from customers that have made changes to the loan policy that were influenced by recent regulatory examinations.  Many times, these changes improved the loan policy as loopholes may be addressed or items in policy are be clarified.  Recently however, it seems these changes have provided a larger box for the financial institution to work within.  A financial institution that is criticized in a regulatory exam for their exception monitoring and tracking may look to reduce the number of items that are considered exceptions within the loan policy.  Some financial institutions have addressed the level of exceptions through changes to their loan policy.  In recent months, I have observed financial institutions that have removed long standing industry practices from the loan policy.  In one example, the explicit requirement to obtain a personal guaranty from the owner(s) has been eliminated from the loan policy.  The financial institution continues to expect the credit structure to include the personal guaranty however if the guaranty is not obtained, an exception to the loan policy is not created.  I have also recently observed a similar type modification to the loan policy through the omission of amortization periods, specifically for C&I deals where the amortization may not be aligned with the useful life of the asset.  Again, an exception is not created if the amortization parameters are not in the loan policy.

As this calendar fiscal year ends, many financial institutions are reviewing and updating policies.  Take a moment to consider if the proposed changes are in-line with the culture and the long-term strategic vision of the financial institution.

Kevin Graff is the President of Integrity Loan Review.  He can be reached at 920-857-6225 or kevin@integrityloanreview.com.

Loan Policy – A Cultural Evolution