View the 2-minute ICBA Independent Banker videos where CRMa Co-Founder, David Ruffin, explains the Credit Lifecycle—the ultimate tie-in between transactional risk and macro portfolio analysis for community banks.
Then, step through the Credit Lifecycle interactive to see how the positive feedback loop formed by the Credit Lifecycle can help your bank.
Why the need for a Credit Lifecycle approach in managing credit risks?
As we begin to acknowledge the differences in transactional credit risk from the more quantitative macro portfolio risk monitoring, we’ll discuss why banks need to embrace both approaches going forward.
What components make up the Credit Lifecycle at your bank?
Five key bank activities where transactional underwriting and macro credit analysis work in concert to impact your bank’s lending and risk management practices.
Impediments you may face in fostering the Credit Lifecycle at your bank?
Finally, we explore potential impediments you may face in creating a Credit Lifecycle at your bank.
Financial institutions have a responsibility to their owners, employees, partners, customers and community to exceed expectations for profitability and security.
CRMa, LLC provides a comprehensive array of credit related products, custom software, and consultative and analytic services. We deliver this “a la carte” and in seamless integration for lending institutions throughout the United States and beyond. Our goal is to identify credit risk objectives, optimize decision making and increase net returns.
Our breadth of expertise combines credit training, underwriting intelligence, policy and regulatory maintenance, loan-to-portfolio risk review and due diligence.
Our goal is two-fold:
Minimize credit, regulatory and market risk while reducing the costs of charge-offs, regulatory fines, penalties, judgments, in-house clerical expenses, opportunity (competency) costs in the marketplace, and additional external audit fees.
The Credit Lifecycle is the basis around which all of our products and services are developed. To be maximally effective, risk management at community banks must be treated holistically and synergistically, and it must span both the transactional underwriting and portfolio management disciplines.
That credit lifecycle revolves around 5 key activities that operate in a continuous feedback loop. We’ll walk through each of these 5 activities.
The first step, even before you underwrite a loan, is establishing and documenting credit policy, guidelines and procedures for each product that your bank offers.
Now that the policy and guidelines are established, we can underwrite loans in the context of these guidelines. Ensure that loan risk grading and approval processes have the capacity to capture credit factors and covenant obligations to lay the foundation for performance monitoring going forward.
The transition between transactional underwriting and macro performance monitoring is the crux of the positive feedback loop. The Underwriting engine in Credit Leader not only helps render a decision, but it also identifies a risk grade and a credit cost—that is, an estimated loss projection at origination. It is this credit cost which will be the primary and most obvious assumption to test over time to monitor whether our original estimate bears out. As we observe positive or negative deviations at the loan, product, vintage and attribute level, we have black-and-white feedback to highlight opportunities to refine our guidelines and / or our pricing. This monitoring also reinforces and refines our credit cost estimate itself based on mined feedback on discrete risk factors like DSCR, LTV, and Score.
So we see that it’s critical to monitor the performance of booked loans in the context of what we learned during underwriting. In addition to portfolio analysis and loss forecasting, it’s also critical to have checks-and-balances on the risk grading function: if we form estimated loss projections based primarily on risk grade migrations, it’s critical to have a well-performing loan review function to monitor risk grade accuracy and completeness (and to update key loan-level credit quality factors as new financial statements and collateral valuations become available).
It’s then important for banks to stress test even these updated and more informed credit considerations in order to quantify the impact to losses, earnings, liquidity and capital under a variety of stressed hypothetical scenarios. The way we think about stress testing is it’s more war game than forecast, helping to form the boundaries around which strategic plans and capital action plans can be grounded and defended. Most banks effectively stress their commercial borrowers through projections; the same logic applies to a bank itself.
With the combination of performance monitoring and stress test analysis along with inputs from compliance, audit and other enterprise risks, the bank can then holistically consider the risks—and opportunities—against its risk appetite, growth and capital plans of the bank.
Credit management can then close the loop and act on this new knowledge by updating guidelines, policies and pricing. Reconsideration of these guidelines allows banks to calibrate product-level credit risk, origination volume and even margin and profitability…The credit lifecycle begins anew.