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Regular and recurring evaluations of asset quality, internal controls and administrative procedures is fundamental to effective risk management


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Loan Review

During these changing economic times, it is essential that financial institutions are well aware of the quality of their portfolio and identify potentially troubled loan relationships as early as possible. Regular and recurring evaluations of asset quality, internal controls, and administrative procedures are fundamental to effective risk management. The need for all banks to have independent, qualified loan review was re-emphasized in a revised Interagency Policy Statement on the Allowance for Loan and Lease Losses issued by the FFIEC in late 2006. The guidance assets that it is... "essential that institutions maintain effective loan review systems...", given the role critical risk ratings and portfolio assessment play in management's assessment of reserve adequacy.

Chaston is fully qualified to meet the needs of both small and large banks for independent loan review. Our firm possesses the resources to build upon controls in place, or assist in the implementation of new and more intensified loan administration procedures within your institution.

The information below highlights CHASTON's methodology and objectives relating to the review of loan portfolios, credit administration practices and the analysis of loan loss reserves. The approach has served our clients in portfolio evaluation and identifying reserve needs, while also assisting in the preparation for future regulatory or external audit reviews.  

We have tailored the process of asset quality review to meet the demands of our client base. Portfolios subject to our review range in size from $10,000,000 to the multi-billion dollar level.   Our typical process targets the analysis of assets most susceptible to risk: the commercial, commercial real estate, investment real estate, and construction loan portfolios. Depending upon the requirements of your institution, the loan review scope can be expanded to include the assessment of consumer, indirect, and residential mortgage loans as well.

The evaluation of commercial/commercial real estate loans incorporates the review of all pertinent credit file information, financial data, financial forecasts, and collateral documentation. An important part of this process is the discussion of the credit relationship with the account officer. Intangible elements of the relationships under review are sometimes only discovered in conversation with the account manager or senior lending officer.   Chaston understands that the time constraints under which we all operate at times do not allow for comprehensive credit documentation. As a result, the most current information regarding a relationship may not yet be part of the credit file. Therefore, Chaston views interaction with the account officer as an essential step in the loan review process.

Our conclusions are typically compiled in a comprehensive report addressed to a senior officer of the bank and/or the Board of Directors. The report is presented in a management letter format and supported by a comprehensive discussion of portfolio quality, systems, policies, procedures and personnel. Individual commentaries may be developed for identified problem assets, particularly when the recommended rating differs from the client's rating.   These summaries focus upon relationship history, financial condition, repayment capacity, collateral, and existing plans for resolution. The typical CHASTON report also contains exception lists addressing financial statements and legal documentation. Compliance with salient elements of the loan policy and credit agreements is evaluated, and testing is conducted to ensure sampled loans are closed in accordance with their approval. The distribution of the targeted loan portfolio is analyzed to assess concentrations by borrower, industry or account officer responsibility. The composite report provides its users/readers with a comprehensive overview of the portfolio, its administration and the adequacy of risk management practices.

As the loan review process is perpetuated through subsequent periodic reviews, the conclusions presented in each report may be compared and contrasted. This allows senior management and bank staff a means to gauge the extent of their response to issues requiring administrative attention and/or changes in asset quality levels over time.

The final segment of our engagement often includes the analysis of loan loss reserve adequacy. This is a natural by-product of the loan review process. As a result of measuring credit risk and the potential for loss, a target for the loan loss reserve can be developed and compared to the client's actual reserve position. Recognizing that there may be no single method for analyzing the reserve that is correct 100% of the time, we often perform our assessment using several approaches. The result is the independent development of a relevant range of reserve adequacy. As part of the reserve assessment process, CHASTON also considers management's own quarterly analysis of this account, providing feedback from the perspective of best practices, as well as compliance with the latest regulatory guidance on this topic.

If you think your bank may be interested in learning more about loan review, please contact Jack D’Ambrosia at (978) 686-3688 or JDAmbrosia@chastonassociates.com.

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