Financial institutions of all sizes are recognizing the need to understand the overall risks of their loan portfolios. While prudent loan approvals and loan performance monitoring are traditional portfolio management tactics, they only address part of the problem. In today’s complex real estate and lending environment, conducting a thorough loan portfolio analysis on a regular basis is a must. Doing so provides you with an understanding of the portfolio’s risk across the board, not just on a loan-by-loan basis.
By using modern analytical tools, portfolio managers can look beyond the standard portfolio-wide credit score to detect early warning signs of increasing risks, view patterns, and, potentially, take action to minimize those risks. Conducting a loan portfolio analysis is a process that requires people, techniques, tools, and other resources. It can be approached by adopting the basic project management lifecycle: Initiation, Planning, Execution, and Closure.
· Initiation – Start by formally committing to the project, in this case, loan portfolio analysis. Who will be responsible for the project? Assign a project manager.
· Planning – Once the project manager has been assigned, he or she will need to define the scope of the project, identify stakeholders, and identify products within the portfolio to be analyzed such as first or second mortgages. Similarly, if any products need to be specifically excluded, they will need to be defined during this planning stage. The methods and tools to be used should be determined as well.
· Execution – Next, it’s time to conduct the analysis. What insights does the analysis provide? Do the key performance indicators indicate exposure to excessive risks? At this point, reports should be compiled and actions recommended.
· Closure – While traditional projects are typically closed and lessons learned recorded, loan portfolio analysis is a process that should be ongoing. After running the initial analysis, corrective and preventative measures should be taken and the process repeated periodically. During closure, it’s helpful to record lessons learned so that the next analysis runs even smoother.
‘The National Credit Union Administration (NCUA) has issued several documents specific to the credit union industry outlining its risk management recommendations. While intended for credit unions, these principles can be used by other lenders. Below are a few of the NCUA’s recommendations:
· Prudence: All asset, liability, and share categories should be approached with prudent policies, realistic limitations, and business strategies.
· Strategic sustainability: What are the risks to net worth and what earnings levels will be required to sustain business strategies under different interest rate and economic conditions?
· Diversification: All asset, liability, and share categories should be properly diversified to minimize risk.
· Evaluation: Risk associated with any new products or increases in loan and asset holding must be evaluated and understood before taking action.
· Diligence: Third-party services, asset and liability transactions, and loan underwriting should undergo both initial and on-going due diligence.
· Control: Risk across all strategies must be measured, monitored, and controlled and adjusted as needed.
By adopting these recommendations and regularly conducting a loan portfolio analysis, it becomes possible to identify, control, and manage risk.