Who Spilled the Milk?

All failures provide learning experiences for us to grow from.  That is, if we are willing to take a critical look at the experience and accept the lessons!  Often, we are too busy to step back and view the landscape and history of a train wreck or worse, we just bury our head and ignore the hurt from the failure. 

This is true in any lending situation.  Anytime a loan goes south, it is a great learning opportunity for the lender and the team.  We must be willing to go to school on the loan and make changes in the places necessary. 

The first place to look is during underwriting.  Was the loan underwritten correctly?  Were any concessions provided to make the deal work which increased the risk?  Higher LTV?  Was a reserve account waived that should have been in place?  Were loan covenants weakened?  What loan exceptions were made to do the deal?

Perhaps the loan was underwritten according to your policy and procedures, but there are weaknesses in the actual policy and procedures.  One institution I worked for decided that they would not require any business financials on business loans that were below a certain threshold.  They decided writing these loans could not be underwritten efficiently.  After millions of fraud and losses, they changed their policy. 

One lender I heard of did a deep dive into a non-profit company and guarantors but failed to look at the operating director of the group.  It was a year after the loan was closed that they discovered racketeering charges toward the director which had existed prior to the loan closing. 

The second place to look is during the life of the loan.  Were financial problems adequately identified when they cropped up?  Was there an attempt to manage the credit and protect the collateral?  Was the borrower forthcoming with the problems or did they go into hiding? 

The life of loan look is not only seeing if problems were identified adequately, but were there adequate procedures to attempt to manage a problem credit?  One issue we learned was to have a standard for the quality and frequency of inspections for loans with commercial real estate as collateral.  One institution I was at allowed a quick drive by inspection on a piece of real estate which failed to show serious issues not viewable from the road.  Another one lost an SBA guarantee because they failed to do an inspection on the property within the proscribed time period allowed when an SBA guaranteed loan payment is missed. 

After this analysis, one should be able to determine where the milk was spilt.  Underwriting or during the life of the loan?   Was the problem isolated to this credit or a problem with your internal management structure, policy, and procedures as a whole?  Are there any changes which should be made there?  Was this a risk identification or risk management failure? 

This report should be written and reviewed as a group along with your policy and procedures on how to manage problem credits.  If you do not have these procedures, you should have a structure and plan on how to work through challenged credits.  Without this, it is like trying to run a professional football game without a playbook.  If handled properly, loan failures can be a marvelous learning experiences.  Perhaps this “spilled milk” report will help prevent future failures in the future.