By David Reno, director of loan review & lending services, Young & Associates
Loan reviews provide institutions with an opportunity to evaluate their credit-granting processes, portfolio composition, and risk-management practices. Although each institution has a unique risk profile, recurring conditions across the lending environment can affect credit performance, staffing demands, and regulatory expectations. Our recent review experience highlights several trends institutions should monitor.
A risk-based approach to loan review
We do not approach loan reviews with a predetermined focus on hot topics. Each institution possesses a variety of risk elements that our diverse loan sample intends to cover. We look for consistent directionality in an institution’s credit-granting process and portfolio composition that aligns with its historical performance, staff expertise and knowledge, available resources, and geographic footprint.
An effective loan review is risk-based rather than one-size-fits-all. The review scope should reflect the institution’s size, complexity, loan types, concentrations, growth patterns, and overall risk profile. In addition to larger or higher-risk credits, a meaningful review may consider new loan products, loans approved as policy exceptions, rapidly growing portfolio segments, and credits with common repayment or collateral risks. This approach helps management assess not only individual credit quality, but also broader patterns that may affect portfolio performance.
Lending strategy and staffing pressures
Most institutions we review engage our services to maintain their established lending approach and strong portfolio performance. Those experiencing problems often have pursued geographically distant lending or launched a new-to-the-bank product that was poorly researched and scaled too quickly.
Finding and retaining qualified credit and lending staff challenges the entire industry. This shortage places added demands on experienced bank employees, who must more closely train and oversee junior staff. Similarly, experienced workout and collection professionals are scarce after more than ten years of favorable economic conditions. We see banks struggle to manage existing or emerging problem credits properly and promptly because of this lack of experience.
Credit risks to monitor
These conditions can compound one another, increasing the importance of timely monitoring, well-supported risk ratings, and proactive borrower communication. Our review experience also points to the following trends:
Non-owner-occupied commercial real estate (non-OOCRE) construction and renovation projects continue to face extended completion time frames because of labor and material shortages and delays. Inflation also contributes to cost overruns. If borrowers do not contribute additional equity, banks may need to increase loan amounts, changing the leverage and debt service coverage (DSC) dynamic.
Similarly, lease-up periods to stabilization for new multifamily construction and repositioned properties are extending. Borrowers may also need to offer unanticipated leasing discounts to increase occupancy.
Emerging credit risks and regulatory pressures
Student housing appears increasingly polarized. Properties near stable or growing institutions continue to perform well, while those in second- or third-tier college towns with declining student populations may experience lower occupancy and rents. Some of these properties are being considered for conversion to market-rate housing. Colleges also continue to develop on-campus housing that competes with investor-owned off-campus units.
Over the past year, we have observed a selective increase in regulatory scrutiny of institutions’ credit quality measurements. After an extended period of more hands-off regulatory oversight during and following the COVID-19 pandemic, certain Federal Deposit Insurance Corp. (FDIC) and Office of the Comptroller of the Currency (OCC) regions and field offices have become more aggressive. As a result, reports of examination (ROEs) may contain, at a minimum, credit and lending matters requiring attention. We expect some matters may escalate to a memorandum of understanding (MOU) or Consent Order after regional or Washington, D.C., offices review the ROE.
Examiner inexperience may contribute to this effect. Newer examination teams may lack the judgment developed through years of examinations and rely heavily on examiner-manual guidance. In some instances, new examiners may take an unnecessarily stringent approach as they seek to establish their reputations, posture for promotion, and attract the attention of supervisors.
Maintaining disciplined credit risk management
The conditions affecting credit quality vary by institution, market, and portfolio, but the need for disciplined credit risk management remains consistent. Institutions should monitor emerging weaknesses early, ensure staff have the experience and support needed to address them, and document actions taken to manage elevated risk. A focused loan review can help management identify developing concerns, assess whether risk ratings remain appropriate and take corrective action before issues become more difficult to resolve.
Stay ahead of loan review changes with Y&A
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