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June 27, 2023

Why Independent Loan Reviews are Necessary for Credit Risk Analysis

Following a long cycle of economic prosperity and low-interest rates, lenders are facing new challenges, from the accelerated shift to remote work to the unprecedented speed of rising interest rates and high inflation. Lower office occupancy rates, higher costs of borrowing and inflation will affect future property valuations, borrower cash flow and customer demand. But there are strategies that can help lenders and borrowers combat these factors and lower risk. 

Now is the Time for a Loan Review 

Identifying potential portfolio changes as early as possible can help lenders and borrowers mitigate risk. Engaging experienced advisors to complete an independent loan review can help financial institutions avoid some of the lending pitfalls that occurred leading up to the 2007-2008 economic downturn. Developing an in-depth understanding of your financial institution’s loan portfolio and credits risks can help your organization develop a plan to face any challenges that lie ahead.  

A loan review performed by experienced, independent advisors can: 

  • Ensure an objective credit risk assessment with a scope determined by your lending institution   
  • Review findings with your organization throughout the entire review process to keep you informed leading up to the exit interview 
  • Provide streamlined, written reports that deliver valuable insights into the risk levels of your loan portfolio 

Selecting a Loan Reviewer with the Right Qualifications 

While it’s appropriate for lending staff to be responsible for ongoing credit analysis due to their frequent contact with borrowers, it’s equally important to ensure an objective assessment. Having loans reviewed by experienced, independent advisors who aren’t influenced by the lending function helps achieve a more objective assessment.  

The review should be performed by a professional with extensive experience performing commercial loan reviews, including experience in areas such as financial and collateral analysis, loan policies and regulations and proper loan structure. These are necessary knowledge points for any loan reviewer to possess in order to effectively convey findings to financial institution management. 

Establishing An Appropriate Loan Review Scope 

The scope should be developed in conjunction with financial institution risk management and must consider various factors including, but not limited to:  

  • Percentage of coverage needed,  
  • Loan type,  
  • Newly originated loans,  
  • Existing loans that are on the high loan-to-value list,  
  • Loans designated as high volatility commercial real estate (HVCRE),
  • Modifications to borrowers experiencing financial difficulty and  
  • Problem credits, etc.

The scope for the loan review process may adjust or change in response to various factors that could expose the loan portfolio to additional or changing risk factors.  Financial institutions have different needs and require critical factors within the loan portfolio to be identified before determining the appropriate scope. 

Determining the Depth of Review 

The depth of review should analyze various factors, including:  

  • Loan structure,  
  • Loan documentation,  
  • Financial analysis and repayment ability, 
  • Guarantor strength,  
  • Collateral protection,  
  • Loan approval,  
  • Compliance with loan policies and procedures as well as laws and regulations,  
  • Ongoing monitoring including payment history and adherence to loan covenants, and  
  •  An appropriate allowance for credit losses on problem credits 

Reviewing Findings Ahead of Exit Interview 

It’s important for a loan reviewer to communicate with the lending staff throughout the review to discuss concerns and potential risk rating changes. This line of open communication is also a great opportunity for the reviewer to get the lending staff’s perspective regarding any credit quality questions or material documentation issues.  

Input from loan officers can be invaluable for loan reviewers and lending staff should learn straight away about important findings, especially those concerning law or regulation violations or findings that can result in a downgraded credit rating. An experienced loan reviewer can balance the level of communication with your organization’s lending officers or executives to keep them informed of potential problems with laws and regulations without being disruptive or cumbersome.  

An exit meeting with appropriate senior management staff should be a recap of material findings your loan reviewer has already discussed. It should provide an opportunity to engage in discussions regarding the contents of the report rather than a first time unloading of the loan reviewer’s findings. The meeting should also cover best practices and trends that may not be included in the report.

Preparing Written Reports 

Lending institutions should expect their loan reviewer to provide them with a streamlined report that focuses on important concerns and issues, including a listing of the loans reviewed and the ratings assigned thereto. If your organization has further questions or would like more information about findings outside of the scope of the loan review, this is the perfect time to bring them up.  

If your loan reviewer has kept you appropriately informed during the course of the review, the information in the report shouldn’t be new or a surprise. Instead, it should spark valuable discussions between executives, loan officers and the loan reviewer. With a thorough loan review, your organization can maintain a robust credit risk review system to keep your lending practices sound and secure. 

The Anders Banking and Financial Institution team closely follows economic and regulatory trends that impact loan quality and includes a group of seasoned loan review professionals with both regulatory and loan officer backgrounds.  Learn more about the loan review services that our professionals routinely provide, including due diligence to assist in M&A activities and supplementing existing internal loan review functions, along with the associated fees, by contacting Anders below. 

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