Happy New Year everyone!
As we begin 2018, here is our "top ten" important items to keep in mind as you manage credit risk this upcoming year. Lots to digest but extremely important.
- Given the rising rate environment, you should stress test the DSCR for all variable rate loans repricing in 2018 and 2019 by increasing the rate 1.00%, 2.00% and 3.00%. In addition, the LTV should be stress tested for all income producing commercial real estate (IPCRE) loans by increasing the Cap Rate by 1.00% and using the current Net Operating Income (NOI).
- Set good credit risk tolerance limits. Best way to do this is to use the Weighted Average Risk Rating (WARR). Once you are confident that all your loans are risk rated accurately, you can use the WARR to control how much risk is in your portfolio, monitor which segments of your portfolio have the greatest risk, and determine how much more risk you can safely take on.
- Review your Pass/Watch loans and see how you can mitigate any weaknesses in these credits. If most of your pass loans are skewed toward your highest pass rating, the probability is greater that you will experience credit challenges in an increasing rate environment or if the economy takes a downturn.
- Pay particular attention to your IPCRE loans where the current NOI does not support debt payments. Compare the NOI based on most recent financial statement/tax return to that used to establish the collateral value and reconcile any material differences. Global DSCR for these loans may be acceptable, but high level of loans that are dependent on secondary source of repayment will eventually lead to credit problems if left unchecked.
- Ensure all your large loans (those comprising more than 25% of your ALLL) have an acceptable WARR and are not skewed towards your highest pass risk rating. Any of these large loans rated Pass/Watch or worse should have excellent secondary (collateral) protection.
- A large exposure in Construction/Land Acquisition & Development loans can lead to serious problems for most community banks. Monitor to ensure these loans are at a manageable level. We recommend limiting these loans to less than 5% of your total loan portfolio or 25% of your Total Capital (unless this is your specialty).
- Loans in any industry concentrations (25% or more of your Tier 1 Capital + ALLL) should be performing at a strong WARR. Most community Banks have a concentration in CRE loans so you should be highly focused on this portfolio. Stay aware of how these concentration industries/properties are projected to perform in 2018.
- Ensure investment in credit administration keeps pace with your growing portfolio so it can be properly maintained. If you did not meet your internal annual review goals in 2017, because resources were consumed with new loan origination, it may be time to hire more credit analysts.
- Become familiar with, and have a game plan, for implementing Current Expected Credit Loss (CECL) ALLL methodology at the Bank. Until the new standard becomes effective, the Bank should follow current US GAAP, along with the related banking regulatory, guidance to prepare the ALLL.
- Have a good independent loan review in place. The "independent" loan review may not necessarily agree with your internal risk ratings. They are there to assign risk ratings based on industry and regulatory expectations. Once they have done that, they should be able to provide you a good impartial assessment of the risks in your portfolio so you can take appropriate action to control credit risk.
We will cover each of the above items in more detail in upcoming releases. If you would like to discuss these, or if you need assistance in accomplishing any of these items due to your current workload, please
us. We are happy to help.
Have a great and prosperous New Year!
Bo Singh, President