COMMERCIAL CREDIT FUNDAMENTALS

Transcription

1 COMMERCIAL CREDIT FUNDAMENTALS Independent Community Bankers of America National Convention 2014 Banking Basics Banks Exist To Fulfill Dreams Bank Product/Service Money/Information Convenience (Facilitate Payments) Wealth Management Build (Investments) Protect (Insurance) Credit (Replace Borrower s Cash Shortfall) Bank s Role in Economy Risk Intermediary Banking is Unique Must Get Product Back to be Successful ( CASH! ) 2 March

2 Risk And Response Banking is about RISK INTERMEDIATION Risk can be managed if aware of the events that will create the risk and necessary mitigation can be implemented With risk comes opportunity; depending on your ability/willingness to deal with the risk. 3 Credit Risk Management Tools Avoid the Risk ( Just Say No ) Take the Risk ( Just Do It ) Mitigate the Risk (Collateral/Derivatives) Transfer the Risk (Participations) Insure Against the Risk (Government Programs) Limit the Risk (Legal House Concentration Lending Authority) 4 March

3 Desired Credit Risk Outcomes Proactively Manage Portfolio Risk (Establish/Manage Expectations ) Adequate Compensation For Risk Taken (Cover Cost of Administration) Timely Capitalization Of Market Inefficiencies (Leverage Your Advantage) Consistent Profitability Over Long-term (Manage Bands of Volatility ) 5 Credit Risk Responses KEY CREDIT RISK ACTIONS No One Ever Makes a Loan Decision; All Decisions Are Portfolio Decisions! You Are Not Paid to Make Loans; You Are Paid to Manage Credit Risks! Operate Within Your Competency Bank Performance Is Intersection Of Its Marketplace And Its Response To That Marketplace 6 March

4 Credit Risk Responses Balance the Credit Paradox Bane of Credit Risk is Finding The Sweet Spot Between Appropriate Amount Of Growth With Appropriate Amount Of Quality Communicate Expectations for Desired Outcome Credit Policy Is Your Strategic Plan For Your Credit Business Focus on the Future Yesterday s Loan Repaid With Today s Cash; Today s Loan Repaid With Tomorrow s Cash! 7 Credit Risk Responses Understand Institution s Credit Culture Maintain Alignment Between Management Objectives And Front Line Personnel Behaviors Reinforce Through Ongoing Communication Its About the Ongoing Message! Manage to Desired Outcome Inspect What You Expect Maintain Proactive Focus on Risk Issues Understand/Manage to Desired Outcomes 8 March

5 Poor Performance Causes Using Best Practices, Not Best Outcomes Matching the Dumbest Competitor Concentrating instead of Diversifying ( Natural Concentration versus Artificial Diversification ) Forgetting/Ignoring the Credit Paradox Greed and Fear Not Understanding or Controlling the Risks Being Taken Mismanaging the Credit Culture 9 Credit Risk Management Actions Make Credit a Strategic Event, not a Tactical Event ( Credit Policy, not Loan Policy) More Emphasis on the Future; Less on the Past Understand Marketplace and Develop Institution s Response (Financial Performance is Intersection of Marketplace Factors and Institution s Response) Measure What Needs to be Managed Manage Probabilities and Consequences Focus on Basics of Sound Credit Risk Management 10 March

6 Strategic Credit Risk Considerations 1) Be Aware of Challenges to Success 2) Understand Marketplace Factors Impacting Institution 3) Develop Institution s Response to Marketplace Factors 4) Implement Risk Management Actions 11 1) Challenges to Success Be PROACTIVE in Assessing Institution s Future Don t just settle for the BFO! Determine Challenges to Success Probabilities Events That Will Impact Risk Consequences Mitigating Risks Taken Assign a Value for Impact on Institution (High/Medium/Low) 12 March

7 Challenges to Success Challenge Probability Consequences Interest Rates Technology Generational Differences Size of Bank Key Driver Covariance Weather/Natural Disaster Market Demographics Labor (Quality/Quantity) Marketplace Infrastructure 13 Challenges to Success Force Rank the Probabilities Low Medium High Force Rank the Consequences Low Medium High Be attentive to High/High; but Don t Lose Sight of the Low Probability/High Consequence Issues 14 March

8 2) Marketplace Factors Know Key Driver(s) Industry Employer Identify/Track Key Driver Influencers Current Situation Anticipated Future Issues Manage COVARIANCE Inter-relationship of Risk Within Portfolio Understand Relationship to Key Driver and Impact on ALL credits in the Portfolio 15 Marketplace Resources ( Beige Book ) (State Profiles/RECON) State Website Chamber of Commerce ( Mainstreet Index ) # 16 March

9 3) Institution Response PROACTIVELY Respond to Challenges to Success Understand Current Marketplace Factors (Starting Point for Risk Response) Assess Future Marketplace Factors (Develop Appropriate Risk Response) Utilize Strategic Credit Risk Framework and Credit Process 17 Be Aware of Stakeholders Community Shareholders Board Senior Management Customers Employees Regulators Vendors 18 March

10 Value Proposition How Will We Make a Profit? Understand Value Proposition and Its Communication to Marketplace Value Proposition Strategies Price Focus Product Focus Relationship Focus 19 Value Proposition Strategy Customer Bank Focus Focus Price Leader Lowest Price Operating Efficiency Product Leader Broadest Product Line Research & Development Product Specialist Niche Leader Product Expertise Relationship Best Total Solution Value Added Service # 20 March

11 Assessing Risk Response Utilize SWOT Analysis Strengths Internal Maximize Weakness Internal Minimize Opportunity External Leverage Threats External Avoid Key is assessing potential outcome of External and Internal Factors (Future Financial Performance) 21 Rolling SWOT Perform on an Ongoing Basis Minimum of Quarterly Updating of Current Year Strategic Plan Involve all Management Include input from staff Include input from customers (New AND Exit) Discussion of issues is more important than appropriateness of outcome! 22 March

12 Rolling SWOT INTERNAL EXTERNAL STRENGTHS WEAKNESS OPPORTUNITIES THREATS Current: Current: Current: Current: WHERE ARE WE NOW? 6-12 Months: 6-12 Months: 6-12 Months: 6-12 Months: WHAT WILL IMPACT OUR ABILITY TO ACHIEVE DESIRED GOALS? 23 Institution Response Actions Determine Institution s Credit Priority (Strategy) Communicate Expectations (Credit Policy) Foster Appropriate Behaviors (Credit Culture) 24 March

13 4) Implement Risk Management Actions Strategic ( WHAT ) 1) Objectives/Philosophy 2) Culture 3) Risk Strategy 4) Risk Controls Tactical ( HOW ) Portfolio Management Portfolio Acquisition Portfolio Maintenance 25 1) Corporate Objectives Credit Priority Manage for Long-term, Consistent Profitability Growth Mixture Quality Unfocused Credit Policy (versus Loan Policy ) Communicate Credit Expectations (Behaviors) Focus on Desired Philosophy (Credit Focus) Manage to Desired Outcome (Culture) Goal is to Properly Manage Bands of Volatility # 26 March

14 Role of Credit Policy Becomes Strategic Plan for Credit Business (Response to Marketplace) Short Term SWOT Desired Outcomes Long Term SWOT Desired Outcomes Used to Communicate Expectations Level of Desirability (Front-end Guidance) Must be Measurable (Strategic) 27 Role of Credit Policy Communicates Desired Behaviors for Front Line Personnel (Credit Culture) Determines Criteria for Credit Review (Inspect What You Expect) Policy Compliance Doing the Correct Things Procedure Adherence Doing Things Correctly Risk Rating Reliability Monitoring/Level of Credit Administration Manage Strategically 28 March

15 Role of Credit Policy Credit Policy, NOT Loan Policy Strategic versus Transaction Outcomes Credit Risk Primary Exposure Direct Risk Secondary Exposure Indirect Risk Establishes Credit Priority Soundness/Quality Profitability Growth Ensure to make Credit Policy YOURS!!!! 29 Credit Policy Content Credit Priority (Philosophy) Trade Territory (Where to Deliver) Lines of Business (What to Deliver) Lending Authorities (Where Does Control Reside?) Credit Criteria (Underwriting Standards/Guidelines) Collateral (Advance Rate/Type/Valuation) Credit Quality Parameters (Acceptable Credit Outcomes/Performance) Exception Management (Manage Higher Risk) Primary versus Secondary Exposure (Manage All Credit) [Focuses on Activities that must be Measured ] # 30 March

16 2) Credit Culture Alignment between Management Objectives and Line Personnel Behaviors Role in Organization Glue connecting Credit Priority and Delivery Tight or Loose? # 31 Credit Culture Descriptions Top Priority Driving Force Credit Environ Hidden Policy Success Factor Values Driven Immed Perform Production Unfocused Long-term, consistent Current earnings; stock Market share; loan Uncertain; tends to performance price. growth; loan volume. change with situation. Corporate values and Annual profit plan. Market plan; desire to be Varies; often search for Market consistency largest. self. Strong credit Generally strong Strong systems and Varies; depends on organization with few emphasis; shift in controls; constantly strength of credit policy exceptions and priority becomes evident being tested by pressure management or current excellent during periods of soft on lenders to produce. priorities. communications. loan demand. Not a factor; consistent with written policy. Strikes a balance between credit quality and revenue generation; avoids tendency to overcontrol lending function. Conflicts with written policy during soft demand periods. Stems from lender confusion over management priorities. Must resist temptation to overreach in down cycle; credit admin must be strong enough to influence lending behavior. Generally dominates written policy; lenders understand that their primary goal is to produce. Loan approval largely controlled by the credit organization; low individual lending authorities. Credit Admin must resist production pressure. Lack of consistency and tendency to shift priorities leaves lenders confused. Dominant leadership provides clear direction; weak leadership leads to change of management. 32 March

17 3) Risk Strategy Determine Results of Inputs Determine Results of Outcomes Manage Appropriately Based on Relationship of Inputs/Outcomes 33 Risk Strategy Inputs Intrinsic Risk Risk Inherent as a Result of Marketplace Concentration Risk Inter-relationship of Risks within the Portfolio Transaction Risk Underwriting Criteria (Standards versus Guidelines) # 34 March

18 Risk Strategy Outcomes Conservative (Proactively Manage 3 of 3) Managed (Proactively Manage 2 of 3) Aggressive (Proactively Manage 1 of 3) # 35 Risk Strategy Actions Maintain ALLL/Capital Adequacy Provide Regular/Appropriate Reporting (MIS) Anticipate Future Outcomes (Stress Testing) Proactively Manage COVARIANCE 36 March

19 4) Risk Controls Focus Credit Priority Action Achieve Alignment Management Objectives Personnel Behavior Result Manage Covariance Outcome Measure Against Priority Can t Manage What You Can t Measure 37 Risk Controls Tools Underwriting (P)/Structure (C) Risk Rating (Potential Volatility to Repayment) Banker Frequency of Monitoring Bank Level of Credit Administration Approval System (Affirmation of Decision) MIS/Reporting (Track Outcomes) 38 March

20 Risk Controls Desired Priority versus Actual Outcomes Approach Must Match Priority Influencing Directing Controlling????????? Understand Appropriate Actions Adjust as Necessary to Achieve Desired 39 Strategic Credit Risk # 40 March

21 Credit Risk Strategic Establish Clear Credit Priority Establish/Communicate Expectations for Frontline Behaviors Inspect What You Expect No one ever makes a loan decision ; every decision is a portfolio decision 41 Strategic to Tactical Issues Be Aware of Marketplace Challenges to Success Rolling SWOT Value Proposition Develop/Implement Strategic Credit Plan Credit Priority Short and Long Term Outcomes Execute Strategic Credit Plan Credit Process Credit Risk Activities Actions to Achieve Strategic Credit Plan 42 March

22 Credit Risk Tactical You Aren t Paid to Make Loan Decisions; You re Paid to Manage Credit Risk! GET THE CASH BACK!! # 43 Manage Credit Risk Determine How to Manage Credit Paradox (Credit Priority) Determine Credit Activities to Achieve Priority (Strategic Credit Risk) Manage for Long-term/Consistent Earnings (Credit Policy) Establish/Manage Credit Tactics (Credit Process) 44 March

23 Credit Risk Management Actions Tactical Process What Needs to be Done to Manage Credit Risk? Systems How Will Credit Risk Be Done? People Who Will Do Credit Risk? 45 Credit Process Components Portfolio Management What Are We Trying to Achieve with Credit? Portfolio Acquisition How Are We Going to Do Credit? Portfolio Maintenance What Do We Do With the Credit Now That We Have It? 46 March

24 Credit Process Framework Corporate Goals Philosophy/ Process Objectives Portfolio Management Target Markets Relationship Priorities Credit Planning Relationship Planning Identify Risks Develop Monitoring Reserves Borrower Analysis Risk Assessment Loan Purpose Administration Profitabilitty Authority/limits Structure Pricing Approval Document Standards Document Control Systems Monitoring Document Creation/ Administration Relationship Administration Credit Review Problem Loan Administration 47 Credit Process Elements Element Process System People Philosophy/Objectives Credit Strategy Credit Policy Board of Directors Portfolio Management Credit Tactics Credit Procedures CEO/President Credit Planning Credit Practice Underwriting/Approval/RR Chief Credit Officer/Senior Lending Officer Relationship Planning Credit Delivery Simultaneous Plant/Prune Banker Borrower Analysis Risk Identification Scoring/Judgment Banker/Analyst Risk Assessment Potential Volatility to Repayment Risk Ratings Banker/Credit Admin Structure Risk Mitigation Credit/Ops/Legal Banker Pricing Cover Cost of Administration Market/Gut/Pricing Model Banker/Credit Admin Approval Affirmation of Decision Serial/Committee/Combination Banker/Analyst Documentation Summarize Agreement Creation/Administration Credit Admin/Banker Relationship Admin Credit Management Monitoring Banker/Credit Admin Credit Review Compliance/Adherence/Reliable Strategic/Tactical Internal/External Problem Loan Admin Loss Mitigation Exit/Rehab Internal/External # 48 March

25 Credit Risk Transactions Credit Risk=P x C Probabilities Events That Will Impact Repayment Identify Risks Analysis Consequences Events Don t Occur as Intended Mitigate Risks Structure Understand/Assess Risk Generators Marketplace Factors Impacting Borrower s Business Borrower s Response to the Marketplace Factors # 49 Credit Risk Assessment MARKETPLACE FACTORS IMPACTING BORROWER S BUSINESS PLUS BORROWER S RESPONSE TO MARKETPLACE FACTORS EQUALS FINANCIAL STATEMENTS # 50 March

26 Credit Risk Focus Commercial Credit Financing the Borrower s Cash Shortfall (CAUSE) Commercial Loan Finance a Self-liquidating Asset (REPAYMENT SOURCE) Properly Managed Credit ALIGNS the Cause with the Repayment Source Key focus is on Getting the Cash Back! # 51 Credit Risk Considerations Analysis Activities Financial Analysis Numbers (Questions) Credit Analysis Events (Reason/Impact) Credit Decision Assess Risk Generators Marketplace Factors Impacting Business Borrower s Response to Marketplace Factors DECISION IS A RESULT OF ANTICIPATING THE FUTURE! # 52 March

27 Credit Risk Considerations Financial Analysis Quantitative Analysis Involves Numbers Obtain Multi-year Data Perform Trending Identify Change Generates Questions Start Point for Credit Analysis Key Tool to Perform Credit Analysis Credit Analysis Qualitative Analysis Involves Events Issues Creating Numbers Generates Explanation of Reason/Impact of Change ( Risks ) Used to Understand Issues Impacting Repayment (Borrower s Response to Marketplace Factors Impacting Business) Key Tool to ANTICIPATING THE FUTURE # 53 Risk Assessment Tools Analysis Approaches Quantitative Numbers Questions Financial Qualitative Events Reason/Impact Credit Financial Analysis Tools 6 Cs (Quick & Dirty) Cash-to-Cash Cycle Cash Drivers Cash Cycle # 54 March

28 Risk Assessment Tools Credit Analysis Tools Marketplace Factors Industry Risk Marketplace Strategy Business Risk Management Risk Focus on FUTURE (Get CASH Back!) 55 Risk Assessment Outcome FUTURE Marketplace Factors Impacting Business PLUS FUTURE Borrower s Response to Marketplace EQUALS FUTURE Financial Statements # 56 March

29 Get The Cash Back Align CAUSE and REPAYMENT SOURCE Understand the CAUSE (6) Understand REPAYMENT SOURCE Asset Being Financed Collateral Establish Appropriate Structure (4) Determine Risk Management Risk Rating Measures Potential Volatility to Repayment Establishes Frequency of Monitoring/Level of Credit Admin Monitor Borrower Behaviors Covenants Documentation Pricing 57 Risk Management Outcomes Manage to Consistent, Long-term Profitability Consider Best Outcome for Bank Develop Risk Management As A State Of Mind Not Just Something To Be Done To Satisfy Regulators Ensure Every Employee Acts as a Risk Manager Focal Point is Credit Policy (Strategy for Credit Risk Management) 58 March

30 Thank You!!!! Home of Jeff s Thoughts A bi-weekly newsletter Jeff Judy & Associates 8701 Lakeview Road Bloomington, MN (952) # 59 March