As I begin to get into this blog post, I first want to thank all 24 students who attended our Agricultural Finance Training in Miles City, Montana last week. It was a great class and we look forward to hosting more of these events in the future.
We also completed our annual NCUA exam. We had a great group of examiners and were able to talk to them about current issues they are running into as they look at business loan portfolios of credit unions. I like to think of them as “red flags”.
No Monitoring of the Business Credit After the Closing: This is one that is still out there in some institutions. Any type of commercial or agricultural lending requires not only obtaining new financial information to keep the file current, but analyzing that information to make sure the risk profile that you have is accurate. Other problems here is a lack of organized file management. This sloppiness makes it hard to figure out what is happening with the credit. If someone else had to take over managing that credit, how easy would they find that task, given your file?
Site Inspections: A lack of documentation of site inspections is found throughout CUs. We are guilty of this as we have been on site to every loan we have closed, yet I had no documentation in the file of the visit. The inspection should be dated, signed, have a listing of the collateral condition, have photos, etc. If you do not have a standard collateral form for inspections, make one up!
Poorly Managed Risk Ratings: We hear of institutions that risk grade all their credits the highest rating they can and then do not change this over the life of the loan. The best practices for risk grading is to have a model that uses several applicable tools of measurement, to make the grading more objective than the officer’s subjective analysis. Risk ratings need to be redone during annual review time and may need to be redone more often should the conditions of the credit deem necessary. A coming trend among the examiners is for you to be able to show the history of the risk grade through the life of the credit. Putting those tracking tools in place now will help you in the future.
Lack of Interim Statements: This hits especially when they are required in the loan covenants. Interims should be used with companies that have not reached stability, complex industries or businesses, or problem credits.
Ignoring or Not Having Covenants: This is when the lender has no follow up on loan covenants. They are not tracked after the closing. There also is ignorance of how to handle a broken covenant and what do you do when you have a broken covenant but decide to waive your rights to penalize the customer or accelerate the note. Generally, there is a lack of covenants, what they do, what to covenant for, and why to use them. The examiners view the institution that avoids the covenant issue completely as laziness.
Poor Loan Structure: This plagues some institutions that think of every commercial loan like a regularly amortizing auto loan. In commercial, there may be instances when creating structures to better capture the business cash flow or requiring curtailments, required principal pay downs, or funding payment reserves may be the best option. A word of caution here is to make sure your core processor can handle a loan with an irregular payment. Better yet, if you can’t do this with your core, we can process the loan with the exotic payment structure at MWBS.
Credit Presentations that Receive a Failing Grade: Too many credit presentations when millions of dollars are being sent out the door do not have adequate content to warrant the loan. A credit write up should be written to the extent that if an auditor, examiner, or loan buyer from another state were to come in to fund the loan, they could read it and understand the deal. Poor or no definition of the loan structure is often found in the write ups. A lack of narrative that explains what is going on, the collateral, market area, or guarantors is evident in a lot of files.
Our deals at MWBS tend to be more complex, so we typically have write ups that begin at 30 pages and go upward from there. But even in our write ups, we still found some ideas to provide additional thoughtful analysis and better cover a few areas where we are a little light on our information. I am not saying that every write up needs to be the size of a good short story, but if you have a large credit, you should have a thorough analysis.
It is my hope that you can understand some of these red flags and avoid them. If you need help, get in touch with us. It is our hope we can help take down some of those warning signs the examiner may find.