Credit Review, ALLL, and SBA and Other Lending

The integrity of credit underwriting and administration processes is fundamental to a lending institution’s health. Credit Reviews are a primary tool for assessing how well those processes are working and their impact on portfolio quality. They start with a sampled loan file review to assess how effectively the various elements of loan and borrower risk identification are being assessed, including the assignment of risk grade for graded loans. Sample size and composition need to be planned carefully by the credit reviewer working with the institution’s credit administrators; appropriate sample selection is critical for being able to extract meaningful conclusions. A loan sample should draw from across the portfolio’s various loan types and should include representation from:

• New loans – to ensure appropriate underwriting at inception
• Adversely-graded loans – to ensure adequate problem-loan monitoring
• Seasoned Pass-graded loans – to ensure responsiveness in the risk grading system to any changes in borrower creditworthiness

But it’s also Portfolio Risk

While the sampled loan file review will always be at the core of Credit Reviews, regulators have rightly come to give increasing emphasis to portfolio-level concerns. After all, banks don’t fail because they miss a loan here or a loan there; rather, it’s correlated credit risk (i.e., concentrations) that constitutes the real danger. Correlation can be by geography (especially for real estate-related loans), industry, loan type or other common factors. It should recognize that when the economy slows, certain parts of the loan portfolio will be more vulnerable than others (think real estate and particularly Construction & Development lending). So, concentration management should be a key element of Credit Reviews, including testing for compliance with the requirements of the 2006 Interagency Guidance on CRE Concentration Risk Management, where applicable. It should also cover single-name risk; one or two very large borrowers going into default could quite literally “bring down the bank.”

Our Credit Reviews also evaluate credit policy documents (vis-à-vis regulatory requirements and expectations), the appropriateness and effectiveness of the risk grading system, various aspects of Board governance and reporting, and the institution’s overall portfolio quality (trends in key metrics, peer comparisons).

ALLL Validations

As a separate though related exercise, we perform regular ALLL validations (audits) to verify that an institution’s Allowance for Loan and Lease Losses (ALLL) methodology aligns with the requirements of the 2006 Interagency Guidance on the ALLL. That guidance specifies regular validation of the methodology. Our approach includes an opinion as to the adequacy of the reserve amount. Meanwhile, we have adapted our ALLL program and reporting to the ACL (Allowances for Credit Losses) in accordance with the more exacting requirements of the new CECL (Current Expected Credit Loss) standard that’s being phased in. We are working with clients to assist them navigate the challenges posed by the migration from the current (incurred loss) approach.

Other Credit-Related Engagements

AuditOne has a highly knowledgeable and experienced team of credit staff to put at your disposal. Besides Credit Reviews and ALLL Validations, that includes advisory work via our affiliated consulting firm, Insight Risk. We have also put our expertise to work assisting many institutions and third parties with due diligence engagements in support of loan portfolios or whole-bank acquisitions. For such engagements – as for all of our work! – we conduct ourselves with high sensitivity to the associated confidentiality and timeliness demands.

We have the “bench strength” to meet many other specific needs as they arise … Mortgage Operations (including secondary market activities), Special Assets, SBA SOP (Standard Operating Procedures), Trade Finance, Asset-Based Lending, etc., etc. Contact us to discuss any aspect of how our Credit Reviews and other lending-related audit processes will help your institution stay “safe and sound” and in compliance with ever-increasing regulatory scrutiny.

Michael Lai has over 35 years’ experience in credit and lending management, as well as a stint as CEO. He earned a BSc. Eng. and an MBA from Hong Kong universities and has attended Executive Management programs at the Harvard and USC Business Schools. He holds CIA (Certified Internal Auditor), CRMA (Certified Risk Management Assurance) and CFE (Certified Fraud Examiner) designations.