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The art of safe lending: How to mitigate commercial loan underwriting risks

Written by admin on . Posted in Advice, Commercial Underwriting, Consultation, Lending & Loan Review.

By: Ollie Sutherin, Principal of Y&A Credit Services

Community financial institutions have long been known for their agility and personalized service, excelling at creating unique lending solutions and facilitating distinct transactions. However, the very attributes that have set them apart may now present fresh challenges as they seek to expand. Community banks and credit unions find themselves navigating a delicate equilibrium: effectively managing underwriting risk, diversifying their loan portfolios, and growing to better serve their communities. 

Additionally, the world of commercial loan underwriting presents its own distinctive challenges that further complicate finding this equilibrium. Commercial loan underwriting standards, in particular, are designed to foster relationship banking rather than transactional interactions. Loans are underwritten based on the borrower’s anticipated ability to operate their business profitably and service the debt being requested. However, the actual cash flows of borrowers can often deviate from expectations, and the value of collateral securing these loans may fluctuate. Most commercial loans are secured by the assets they finance, along with other business assets such as accounts receivable or inventory, and sometimes entail personal guarantees. Loans secured by accounts receivable heavily rely on the borrower’s ability to collect due amounts from customers. These complexities create a web of considerations for underwriters. 

Effective management of a community financial institution’s loan portfolio necessitates a strategic approach guided by skilled underwriters who play a pivotal role in mitigating underwriting risks in commercial lending. 

The aftereffects of the SVB collapse 

A little over six months have passed since the financial world experienced a seismic shift when a prominent regional bank collapsed. This event sent shockwaves throughout the banking sector, triggering a chain reaction that affected numerous other financial institutions, both regional and local. These far-reaching consequences have also left their mark on various aspects of community bank and credit union operations. 

Risk management has always held a pivotal role in credit underwriting, and its significance has become more pronounced in today’s ever-volatile environment. As we navigate an era of monetary tightening, global inflationary pressures, and increasing interest rates, underwriters find themselves under increased scrutiny. In the past, cheap funding was abundant, but now, risk-appropriate pricing is paramount for funding new deals. Underwriters must balance a new interest rate environment with the heightened lending and refinancing risks, necessitating increased diligence in risk assessments when extending credit and negotiating terms. 

To shed light on this matter, we will explore effective strategies for community financial institutions to limit underwriting risk in commercial lending, ensuring they can thrive while maintaining a prudent approach to lending.  

Comprehensive credit analysis 

The cornerstone of any sound underwriting process is conducting a comprehensive credit analysis. This involves digging deep into the current financial health of the borrower, their business, and the industry they operate in. By meticulously assessing factors like cash flow, collateral, and credit history, you can gain a clearer picture of the borrower’s ability to repay the loan. 

Moreover, consider working with an experienced outsourced credit underwriting service like Y&A Credit Services to ensure you have access to the latest data, analytical tools, and expertise in evaluating commercial loans. Our team of experts can assist from reviewing your analysis to completely underwriting the transaction, ensuring you have all the information to help you make informed lending decisions. 

Diversification of loan portfolios 

Diversification is a risk management principle that rings true in commercial lending as well. By diversifying your loan portfolios across various industries and business types, you can reduce your exposure to sector-specific risks. A balanced mix of loans in manufacturing, real estate, healthcare, and other sectors can help buffer your institution against economic downturns that may affect a particular industry. 

Loan covenants and monitoring 

Establishing clear and enforceable loan covenants is another key step in limiting underwriting risk. These covenants set out the terms and conditions under which the borrower must operate and repay the loan. Regularly monitoring the borrower’s compliance with these covenants and requesting the most current information from your borrower is equally important. It allows you to detect early warning signs of financial distress and take corrective action sooner when you have more options for a successful outcome for both your borrower and your institution. 

Loan portfolio stress testing 

Stress testing is an invaluable tool for gauging how your loan portfolio would perform under adverse conditions. By modeling various scenarios against your portfolio, you can assess your institution’s vulnerability to economic shocks and make proactive adjustments to your lending practices. 

Ongoing training and education 

Staying up to date with the latest industry trends, regulations, and best practices is essential. Encourage your staff to engage in ongoing training and education programs related to commercial lending and underwriting. This ensures that your institution’s underwriting processes remain current and effective. 

Regular commercial loan underwriting reviews 

To maintain the health of your loan portfolio, it’s crucial to conduct regular reviews of your commercial loan underwriting practices. This ensures that your institution’s standards and processes align with the evolving landscape of commercial lending. It also allows you to make necessary adjustments and refinements to minimize underwriting risks continuously. 

Outsourcing commercial credit underwriting 

Third party assistance for commercial credit underwriting can help to ensure the accuracy and effectiveness of your underwriting processes. It can relieve your institution of the need to maintain an up-to-date full-time staff.  Professional outsourced services, like Y&A Credit Services, offer expertise, access to advanced analytical tools, and an impartial perspective. We help your institution make sound lending decisions and maintain high underwriting standards.  These services can be implemented from fully outsourced to fractional, helping assist during peaks in volume.  

Y&A Credit Services’ guidance in commercial underwriting 

Mitigating underwriting risk in commercial lending is pivotal for upholding financial health and stability of community banks and credit unions. Especially in the wake of the industry upheaval earlier this year. By implementing comprehensive credit analysis, diversifying loan portfolios, enforcing loan covenants, conducting stress tests, and investing in ongoing training, regular reviews, and outsourcing, you can confidently navigate the complexities of commercial lending while minimizing risks and enhance your institution’s lending capabilities. 

At Y&A Credit Services, we understand the importance of risk management in commercial lending. We’re here to guide you through the process. Our outsourced credit underwriting services are designed to offer the expertise and resources needed to make sound lending decisions. Together, we can build a more secure lending future for your institution, helping our communities one loan at a time. 

Contact us today to learn how we can help. 

Considerations for AI adoption at community financial institutions

Written by admin on . Posted in Advice, Consultation, Information Technology.

By: Mike Detrow, CISSP 

You have probably seen the headlines claiming that artificial intelligence (AI) models such as ChatGPT will soon replace many human jobs. Marketing campaigns are also touting its use by vendors to improve the effectiveness of their data analysis tools. If you haven’t thought about the application of AI for banking operations, you will likely be evaluating it soon. Just as with any other risk management practice, it is best to evaluate new technologies proactively. As opposed to waiting until your vendors force you or your employees begin using them without your knowledge. 

The purpose of this article is to identify the risks associated with machine learning and generative AI that you should consider as you are evaluating use cases for it at your financial institution. Machine learning is the use of training data and algorithms that allow computers to imitate intelligent human behavior more realistically. Generative AI uses machine learning to allow a computer to generate new content such as text, images, video, or sounds.

The role of AI in financial institutions: A look at practical applications 

First, let’s explore potential use cases for artificial intelligence in community financial institutions. Some of the applications that we have seen so far include: 

Risk factors for implementation in community financial institutions 

Next, let’s examine some potential risks associated with the use of artificial intelligence in community banks and credit unions. One of the biggest concerns with the use of AI is the security of non-public information. Entering such data into an AI model that is not under the complete control of the financial institution or one of the institution’s vendors introduces the risk of this information being disclosed, resulting in the potential misuse of this sensitive data. 

In addition to security concerns, there are other risks that should be considered. Results provided by AI-driven decision-making models could be biased based on the data that was used to train the model. Also, the information provided by AI models may be inaccurate or misleading.

Building a strong foundation for AI risk management

Now that you are aware of the risks associated with artificial intelligence, what should you do to evaluate its potential within your bank or credit union? To safeguard your financial institution in the era of rapid AI adoption, it’s imperative to set guidelines early. The first step is to establish a group within your institution that will provide oversight for AI. If you already have an IT Steering Committee, this role will likely be assigned to this committee as it should already include the appropriate employees for this task. If you do not have an IT Steering Committee, you should consider establishing a cross-functional group of employees drawn from various areas of the institution to handle AI oversight. 

The first initiative for your AI oversight group should include a discovery process to identify any existing use of AI at the financial institution. It is possible that employees are already using ChatGPT to help develop marketing materials, for writing scripts or macros, or they may be using web browser plugins to improve productivity. Some of your vendors may also be using AI for various tasks associated with delivering services to your financial institution or customers, such as AML models, loan underwriting, and website virtual assistants or chatbots.  

This group should develop a plan to identify any employee use of AI, whether it be through engaging in conversations with employees or potentially through employing the use of web traffic analysis. Keep in mind that your IT staff may not be the only employees that are potentially using AI within your financial institution.  

Additionally, your oversight group should review vendor documentation and, if deemed necessary, reach out to vendors to determine how they may be using AI. The discovery process can determine whether current or prior employee or vendor use of AI has put any non-public data at risk. You can then take appropriate actions to address potential data misuse and prevent further inappropriate AI usage.

Once the oversight group has identified existing utilization of AI by employees and vendors and addressed any potential security concerns, the next step is to formally establish the institution’s risk appetite related to AI. This is achieved by documenting it within a policy that will be approved by the board and provided to employees for their acknowledgement. You should consider the following criteria within your policy: 

  • Definition of AI and the associated risks 
  • Authorization Process: Clearly defined IT Steering Committee approval requirements for new use cases. 
  • Vendor Risk Management: Due diligence practices for new vendors and ongoing monitoring of existing vendors to understand their AI usage and the potential risks involved. 
  • Acceptable Use: Employee guidelines for the usage of AI models such as ChatGPT and browser plugins, data security, output verification process, etc. 
  • Ethical and Legal Requirements: Guidelines for nondiscrimination, regulatory compliance, and adherence to other institution policies. 
  • Intellectual Property Protection: Measures to safeguard intellectual property rights and copyrighted material.
  • Incident Response: Procedures to detect and report any suspected security incidents. 

Note: It is likely not feasible to implement an outright ban of AI at the financial institution within your policy. Especially as some of your vendors are likely already using AI or will be using it in the near future. 

The use of AI expected to increase very rapidly over the next few years. It is imperative to establish guidelines for its use as early to limit the potential for its misuse.

Y&A’s solution for secure AI adoption and risk preparedness

In the rapidly evolving landscape of artificial intelligence integration within the financial sector, striking a balance between reaping the potential benefits of this technology and practicing effective risk management can be challenging. It’s crucial to adopt a risk-ready approach to scaling AI integration in order to safeguard the future of your institution. The proliferation of AI applications shows no signs of slowing. This makes it wise to proactively address risks before regulatory measures come into effect. 

To streamline the process of addressing risk, we offer a customizable AI policy for your financial institution’s specific needs. Click here to learn more about this product.

For any questions, reach out to Mike Detrow, Director of Information Technology, at mdetrow@younginc.com or contact us on our website.

Overdraft programs and fees: Navigating the regulatory maze

Written by admin on . Posted in Advice, Compliance & Regulations, Consultation.

By: Karen S. Clower, CRCM and William J. Showalter, CRCM, CRP

Fee income practices in overdraft programs have garnered increasing attention from regulatory bodies such as the CFPB, OCC, NCUA, and FDIC. The risks associated with overdraft practices are growing, and overlooking them can pose significant threats to your financial institution.

These regulatory developments are of particular concern for both APSN (Authorize Positive, Settle Negative) and NSF (Non-Sufficient Funds) fee practices. With both federal and state regulators scrutinizing these areas, it’s a critical time for financial institutions to review their overdraft and insufficient funds procedures. Unpacking the intricate world of overdraft programs, understanding fair banking risks, and adopting best practices to mitigate them have never been more crucial.

Multiple re-presentment fees under the microscope

The FDIC revised their Supervisory Guidance on Multiple Re-Presentment NSF Fees in June 2023. The core message from this guidance is the importance of transparency in re-presentment practices. The FDIC emphasizes that re-presentment practices may be deceptive when lacking clear disclosure and unfair when they lead to the assessment of multiple NSF fees for a single transaction.

A re-presentment occurs when a transaction is initially declined due to insufficient funds, followed by the merchant resubmitting the transaction, which may incur additional NSF fees. In many instances, customer disclosures do not fully convey the nature of these re-presentment practices, elevating the risk of consumer harm and regulatory violations. It is prudent for financial institutions to review and update disclosures to avoid causing consumer harm and accumulating violations.

Identifying potential risks associated with NSF fees on re-presented transactions

Examiners have identified several risk factors related to the assessment of NSF fees on re-presented transactions:

  • Consumer compliance risk: Charging multiple NSF fees for the same unpaid transaction can breach Section 5 of the FTC Act, which prohibits unfair or deceptive practices. Not adequately informing customers can mislead and potentially harm them.
    • Deceptive Practices: The FDIC finds charging multiple NSF fees without proper disclosure deceptive.
    • Unfair Practices: Inadequate customer advice on fee practices can be unfair, particularly if it causes harm and offers no benefits to the consumer.
  • Third-party risk: Third-party involvement in payment processing and tracking re-presented items can lead to risks. Institutions should monitor these arrangements closely.
  • Litigation risk: Charging multiple NSF fees may lead to litigation. Many institutions have faced class-action lawsuits and substantial settlements for inadequate fee disclosures.

Managing NSF fee risks

The FDIC encourages financial institutions to review their practices and disclosures regarding NSF fees for re-presented transactions. Note that a highlight of the most recent update to their supervisory guidance is that their current approach does not involve requesting financial institutions to conduct lookback reviews absent a likelihood of substantial consumer harm. To mitigate the risk of consumer harm and legal violations related to multiple re-presentment NSF fees, financial institutions are encouraged to consider the following:

  • Eliminating NSF fees.
  • Charging only one NSF fee for the same transaction, even if it’s re-presented.
  • Reviewing policies and practices, clarifying re-presentment practices, and providing customers with updated disclosures.
  • Clearly and prominently disclosing NSF fee amounts, when they are imposed, and the conditions under which multiple fees may apply to a single transaction.
  • Reviewing customer notification practices and fee timing to enable customers to avoid multiple fees for re-presented transactions.

These recommendations are based on supervisory observations to date and do not impose any legal obligations to financial institutions. While not mandatory, these steps help in reducing the risk of consumer harm.

FDIC’s supervision of re-presentment NSF fees: A closer look

The FDIC has a specific approach when it comes to overseeing and enforcing regulations regarding multiple re-presentment NSF fee practices. Their main aim is to identify and correct issues related to re-presentment, with a focus on ensuring that customers who have been harmed receive the necessary solutions.

As part of their process for assessing compliance management systems, the FDIC acknowledges institutions that take proactive steps to identify and rectify violations. Importantly, if institutions have already addressed these violations before a consumer compliance examination, examiners generally won’t cite UDAP violations.

When financial institutions proactively identify issues related to re-presentment NSF fees, the FDIC has clear expectations:

  • They should take corrective actions, which include providing restitution to affected customers.
  • There should be a prompt update to NSF fee disclosures and account agreements for all customers, both new and existing.
  • Consideration should be given to implementing additional risk mitigation practices to reduce potential unfairness risks.
  • Monitoring of ongoing activities and customer feedback is essential to ensure that corrective actions are sustained over time.

The FDIC evaluates the need for restitution by considering the potential harm to consumers as a result of the practice, the institution’s record-keeping practices, and any challenges associated with collecting and reviewing transaction data or information related to the frequency and timing of re-presentment fees. In cases where examiners identify law violations related to re-presentment NSF fee practices that have not been self-identified and fully corrected before an examination, the FDIC may contemplate various supervisory or enforcement actions, including the imposition of civil monetary penalties and the requirement for restitution where necessary.

What about APSN fee practices?

The regulatory focus extends beyond just re-presentment fees. One noteworthy concern is the practice of charging overdraft fees for transactions that were initially authorized with a positive balance but later settled with a negative balance, referred to as APSN transactions. Below is an overview of the FDIC’s Supervisory Guidance on Charging Overdraft Fees for Authorize Positive, Settle Negative Transactions, which was revised in April 2023 to expand upon the related 2019 Supervisory Highlights article.

Guidance overview

Complexity in Overdraft Programs: Overdraft programs, transaction clearing, and settlement processes are intricate. APSN transactions involve consumers being assessed overdraft fees when they had sufficient account balances at the time of transaction initiation but no longer at settlement. This means it is hard for consumers to predict when fees might be assessed and how to avoid them.

Available Balance vs. Ledger Balance: Financial institutions typically use either an available balance method or a ledger balance method for assessing overdraft-related fees. The available balance can be affected by pending debit transactions. Some institutions, especially with the available balance method, assess overdraft fees on transactions authorized when the available balance is positive but posted when the balance is negative.

Unintended Consequences: In some cases, this practice leads to multiple overdraft fees being charged. Unanticipated overdraft fees can cause considerable harm to consumers. The consumer cannot reasonably avoid these fees, and their complexity further compounds the issue. This situation raises the risk of violations of consumer protection laws.

Mitigating risks: Financial institutions are encouraged to review their practices regarding charging overdraft fees for APSN transactions. This entails ensuring that customers are not charged overdraft fees for transactions they could not anticipate or avoid. This includes monitoring third-party arrangements for compliance, evaluating core processing systems, and improving disclosures to accurately convey fee practices.

With a deep understanding of re-presentment and APSN transactions, financial institutions can effectively navigate the complex landscape of fee income and compliance. A proactive approach can aid in protecting consumers, ensuring regulatory compliance, and maintaining your institution’s reputation.

Balancing overdraft fee income and compliance

Weighing compliance and reputational risks against the revenue your overdraft program generates is crucial. While fee income is essential, safeguarding your financial institution’s reputation should always be a top priority. Striking the right balance between compliance and revenue is key.

Regulatory insights and recent enforcement actions

To stay ahead in the realm of overdraft programs, monitoring the insights and actions of regulatory bodies is essential. The CFPB, FRB, OCC, NCUA, and FDIC provide guidance and updates that can directly impact your operations. Recent enforcement actions underscore the consequences of non-compliance. Analyzing these cases can provide insights into areas where institutions have faltered and help you steer clear of similar missteps.

Your overdraft compliance solution: Young & Associates

Managing overdraft programs while staying compliant with fair banking regulations is a complex task. At Young & Associates, we are here to guide you through this maze. We help ensure that your institution not only thrives financially but also maintains a strong reputation. By understanding the risks, learning from common pitfalls, and implementing best practices, you can create a robust overdraft program..

For more in-depth guidance tailored to your unique circumstances, reach out to our team of experts. Together, we can navigate the regulatory compliance landscape and keep your financial institution on the path to success. Contact us today.

How strategic planning drives effective change management

Written by admin on . Posted in Advice, Change Management, Consultation, Human Resources, Management & Planning, Strategic Planning.

By: Michael Gerbick, COO 

Change is an undeniable aspect of the modern financial world. To stay competitive, thrive in a dynamic marketplace, and satisfy the demands of both customers and regulators, banks and credit unions must embrace change management as an integral part of their strategic planning process. But how can financial institutions seamlessly integrate change management into their strategies while ensuring their governance processes remain robust enough to meet regulatory requirements? Understanding this symbiotic relationship and how to strategize for achievement is vital.

The unavoidable reality: Change in the financial sector

The significance of change management in the bank and credit union industry has gained even more prominence in recent times. In the Fiscal Year 2024 Bank Supervision Operating Plan released by the Office of the Comptroller of the Currency Committee on Bank Supervision, change management takes center stage. The plan underscores the importance of banks implementing significant changes in various aspects of their operations, from leadership to risk management frameworks, and even in their use of third-party service providers that support critical activities.

The operating plan emphasizes the role of examiners in identifying these financial institutions and evaluating the suitability of their governance processes. This includes assessing whether the acquisition or retention of qualified staff aligns with the changes undertaken by the board or management. These changes can arise from a variety of factors, including mergers and acquisitions, system conversions, regulatory requirements, and the implementation of new, modified, or expanded products and services, such as cutting-edge technological innovations.

This regulatory focus underscores the critical nature of integrating change management into the strategic planning process for banks and credit unions. It is not just about responding to the evolving landscape; it is about proactively steering the ship towards a brighter, more competitive future. Change is a constant in the financial sector. Market dynamics, technological advancements, shifting customer expectations, and regulatory updates all contribute to the perpetual evolution of this industry.

For banks and credit unions, change should not be a reactive response; it should be a proactive strategy. Strategic planning, often seen as the roadmap for an organization, is the mainstay that can help financial institutions navigate these uncharted waters. However, the true synergy lies in integrating change management into this planning process.

The power of change management

Change management, at its core, is about guiding an organization through the transition from its current state to a desired future state while minimizing disruptions and ensuring that the change is well-received by employees and stakeholders. In the context of banks and credit unions, effective change management can manifest in various forms, such as:

  • Digital transformation: Embracing new technologies to enhance customer experiences and operational efficiency.
  • Compliance updates: Adapting to evolving regulatory frameworks to avoid penalties and maintain trust.
  • Cultural shifts: Fostering a culture of innovation and adaptability among employees.
  • Product and service enhancements: Continuously improving offerings to meet customer demands.
  • Proactive risk assessment and management: Identifying, mitigating, and seamlessly integrating risk management to safeguard against potential risks and challenges.

The crucial role of change management in this industry cannot be overstated. It enables financial institutions to execute their strategic visions successfully, transforming conceptual ideas into concrete actions.

Incorporating change management into your financial institution’s strategic planning

To weave change management seamlessly into your strategic plan, consider the following steps:

  1. Establish a clear vision: Clearly define your strategic objectives and the desired outcomes of the change initiatives. Ensure that your team understands and is aligned with this vision.
  2. Identify key stakeholders: Recognize the individuals and groups affected by the proposed changes. Engage with them early to gather insights, address concerns, and gain their support.
  3. Create a robust governance framework: Robust governance processes are essential for change management in banking. This includes defining roles and responsibilities, establishing decision-making processes, and setting up regular progress tracking mechanisms.
  4. Develop a communication strategy: Effective communication is the backbone of change management. Craft a comprehensive plan to keep stakeholders informed, engaged, and motivated throughout the change journey.
  5. Build change champions: Identify and empower individuals within your institution who can serve as change champions. They can help drive the transformation and inspire their colleagues.
  6. Monitor and adapt: Regularly assess the progress of your change initiatives and be ready to adjust your strategies as needed. Change is iterative, and adaptability is key to success.

Incorporating change management into strategic planning is critical. By establishing a clear vision, engaging key stakeholders, creating a robust governance framework, crafting effective communication strategies, building change champions, and embracing adaptability, your financial institution can navigate change seamlessly and achieve its strategic objectives.

Governance processes: Meeting regulatory requirements

Incorporating change management into your strategic plan does not mean sacrificing regulatory compliance. In fact, it can enhance your ability to meet these requirements effectively. Here is how you can navigate this regulatory landscape while optimizing your change management efforts:

  • Risk assessment: Conduct comprehensive risk assessments to identify potential compliance gaps and challenges associated with your proposed changes. Address these issues proactively and effectively to minimize regulatory risks.
  • Regulatory engagement and collaboration: Establish open and constructive lines of communication with regulators and examiners. Keep them informed of your change initiatives, seek their insights and guidance on change management strategies, and demonstrate your commitment to compliance.
  • Documentation and reporting: In line with regulatory requirements, maintain meticulous records of your change management efforts, including compliance measures. Thorough and accurate documentation can simplify examinations and audits, making the process smoother and more efficient.
  • Training and education: Invest in training and educating your staff on regulatory changes and their implications. Knowledgeable employees are your first line of defense against compliance issues.
  • Continuous improvement: Remember that change is perpetual. Continuously assess and adapt your change management strategies to stay ahead in a rapidly evolving industry.

By following the strategies outlined above, you can navigate the complex regulatory landscape while optimizing your change management efforts and harmonizing change with compliance. Embrace these practices, and your organization will not only thrive in the face of change but also meet regulatory demands with confidence and efficiency.

Embracing proactive change management

Change management is a function of an effective strategic plan. The symbiotic relationship between them is the cornerstone of success in modern financial institutions. Embracing change as an opportunity, rather than a challenge, is crucial. Integrating change management into your strategic planning process, establishing robust governance procedures, and ensuring regulatory compliance are the keys to thriving in an ever-evolving industry.

Remember, change is not a one-time event but a continuous journey toward a brighter future for your institution and stakeholders. Align your strategic planning with regulatory directives and embrace change management as a proactive strategy to not only meet regulatory demands but also position your institution as an industry leader in the dynamic financial landscape. Embrace change, and let it steer your institution toward success.

Young & Associates: Your partner in change

Y&A is here to support financial institutions as they navigate the ever-evolving landscape of the financial industry. With our team’s extensive experience in regulatory compliance, risk management, and strategic planning, we stand ready to assist you in successfully embracing, harnessing, and facilitating change. With over 45 years of proven experience as a trusted ally to financial institutions, you can rely on Y&A to guide through the financial sector’s changing terrain. Get in touch with us to learn how we can help.

Succession planning strategies for developing your leadership legacy

Written by admin on . Posted in Advice, Consultation, Management & Planning, Succession Planning.

By: Clarissa Sinchak, PHR, Director of Human Resources

An aging workforce is an increasing concern for many financial institutions, but with thoughtful planning and a solid road map in place, it is possible to leverage the strengths of these invaluable, loyal, and tenured employees while concurrently planning for the future and growth of your organization.

Understanding workforce age trends and the road ahead for succession planning

According to recent studies, the baby boomer generation, comprising individuals aged 57 and older, reflects nearly 20% of the overall U.S. workforce population. However, according to the Bureau of Labor Statistics, this same group of workers represent an even higher percentage in the financial services and banking industries – nearly 24% of the overall workforce. As such, it is important for business leaders to address this demographic shift proactively to ensure continued success of their organizations.

While the expertise of older employees is incredibly vital, there are some key challenges that an ageing workforce presents as it relates to sustaining the future of the company. Naturally, as senior employees retire, financial institutions may inevitably face a skills gap if there are not enough younger employees with the necessary skills and experience to fill these roles. This can have a negative impact on the overall morale and ultimate retention of these younger workers, not to mention an adverse effect on the continued growth and stability of the company. So, what can executive management do to help mitigate this issue?

Proactively managing the challenges of an aging workforce

To address the challenges of an aging workforce, financial institutions must adopt proactive strategies. First and foremost, focus on upskilling by providing training and development opportunities to help newer employees acquire new skills and adapt to evolving job requirements. Secondly, transfer knowledge! The natural attrition of experienced employees that all financial institutions are facing can result in a loss of institutional expertise, so it is crucial to facilitate knowledge transfer from retiring workers to younger ones.

This can be accomplished through structured training, ensuring that this valuable expertise remains within your institution. Seasoned employees bring decades of wisdom as well as unique perspectives and ideas to the workplace. They can serve as mentors and advisors to their younger counterparts, contributing to their development. Additionally, older workers also have a clearer understanding of the needs and preferences of your valued and loyal long-term clients, which can provide a competitive advantage when training their successors.

Where to begin: The foundation of succession planning

The question then becomes, “Where do we start, and how?”. Planning for leadership transition via succession planning is the answer to ensure long-term success and stability of an organization. But what exactly is succession planning?  Simply put, it is the process of developing a program to identify and prepare younger employees to take on leadership roles as their more senior counterparts retire.

Effective succession planning in financial and banking institutions reduces the harsh risks associated with leadership turnover, helps maintain overall institutional knowledge, and ensures an ongoing pipeline of qualified leaders who can navigate the ever-changing and highly regulated world of banking. In other words, succession planning ultimately contributes to the long-term stability and success of the industry and is crucial for guaranteeing a smooth transition of leadership while maintaining continuity in key positions.

Most organizations believe in the practice of succession planning, but many lack a standardized process for executing it. Or, if such a process does exist, typically too much time is spent on this traditionally time-consuming process. On the flip side, it’s not as simple as identifying, training, and placing employees.

Therefore, to begin the process of developing your financial institution’s future leaders, we recommend incorporating succession planning into your current performance management process. This strategic approach allows you to identify and develop your potential future leaders and create a talent pipeline that ensures a smooth transition of leadership and key positions. By aligning your company’s core competencies and the outcomes of your employee evaluations with your succession plan, you can ensure that you have a pool of qualified workers to fill key roles when transition time comes. This results in a methodical and proactive approach to leadership development.

Implementing succession planning in your financial institution

To help you begin this process, we have outlined ten key steps for developing an effective succession plan for your financial institution:

1. Align the succession plan with your financial institution’s goals

Begin by aligning your succession plan with your institution’s strategic goals. Identify the key positions throughout the entire organization that are critical to achieving those goals and prioritize them for succession planning. Typically, these are C-suite roles (CEO, COO, CFO) and other key executive positions, but remember to consider leadership roles at lower levels that are critical to your bank or credit union’s success.

2. Hold succession planning meetings with leadership

Hold planning meetings with the key stakeholders of your financial institution as part of your talent review process. During these meetings, discuss the progress of high-potential employees, review their career development plan, and identify potential successors for critical positions.

3. Define key positions

Start by identifying critical roles within the organization that require succession planning. These are typically leadership, management, or specialized positions that are essential for the institution’s success. Clearly outline the criteria, competencies, and qualifications required for individuals to step into these leadership roles. Develop contingency plans for unexpected leadership openings. Identify interim leaders or backup candidates who can step in temporarily while a permanent replacement is identified and groomed.

4. Communicate and ensure transparency

It is crucial that you ensure employees are aware of the succession planning process and its importance within the institution. Make sure to incorporate this discussion into your performance evaluation meetings with your team. Transparent communication can motivate employees to actively participate in their own development. It also fosters engagement which is critical in retention.

5. Conduct ongoing performance discussions

Conduct regular performance meetings, not just as an annual evaluation tool, but also as a forum for discussing an employee’s progress toward their development goals. Use their reviews to provide feedback and adjust their career development plan as needed. Managers should provide guidance on how employees can prepare for future roles.

6. Identify high-potential and high-performing employees

Within your performance evaluation process, assess and identify high-potential and high-performing employees who have the skill sets, competencies, and interest to fill the previously determined key positions in the future. This can be done through performance reviews, ongoing feedback, and in-depth goals discussions.

7. Create individual career development plans

Work with the high-potential, high-performing employees you identified to create Individual Career Development Plans. These plans should outline their career goals, areas for development and improvement needed, and the training and experiences needed to prepare them for future roles. Also, set clear performance goals that are directly related to the competencies needed for succession in key positions. These goals should be specific, measurable, achievable, relevant, and time-bound (SMART).

8. Assign senior mentors

Assign mentors or coaches to the employees identified as future leaders. Seasoned mentors can provide guidance, share their knowledge, and help employees develop the skills necessary for future roles. This can be done through workshops, seminars, and on-the-job training. Also, encourage cross-training and job rotations to expose high-potential employees to different areas of the organization and broaden their skill sets.

9. Regularly monitor progress

Continually monitor the progress of your succession plan and adjust as necessary. Succession planning is an ongoing process that should evolve with changing organizational needs.

10. Ensure consistency and ease of use

Having an uncomplicated, consistent process makes it possible to maintain objectivity across all departments. To develop a comprehensive succession strategy that will benefit your financial institution, executive management must recognize that each institution needs to develop a process that fits its own specific strategic goals and objectives.

Ultimately, it is important to remember that a successful succession plan should be flexible and adaptable to changing circumstances. It’s an ongoing process that should evolve as your community bank or credit union does. By investing in developing your leadership legacy, you can build a strong and capable leadership team that can direct your financial institution into the future.

Partnering with Young & Associates for succession planning

At Young & Associates, we understand the unique challenges and opportunities faced by financial institutions in managing an aging workforce and preparing for leadership transitions. Our team of seasoned experts specializes in providing comprehensive consulting services tailored to the specific needs of banks, credit unions, and other financial institutions.

Don’t wait until the challenges of an ageing workforce create disruptions in your institutions. Partner with the Y&A team to develop a robust succession plan that guarantees a smooth transition of leadership. Also, we help you maintain continuity in key positions, and contribute to the long-term stability and success of your institution. Get in touch with us today to discuss your specific needs and challenges.

Elevating your financial institution: Why Young & Associates is your trusted partner for success

Written by admin on . Posted in Consultation.

The Young & Associates advantage

In the fast-paced world of banking and credit unions, the stakes are high, and the landscape is ever-changing. As you gear up for the upcoming year, you need a strategic partner you can trust. One with a proven track record, unmatched expertise, and an unwavering commitment to your success.

45 years of trust and excellence

For nearly half a century, Young & Associates has been at the forefront of the financial industry, helping banks and credit unions thrive in an evolving marketplace with consulting, outsourcing, and education services. Our longevity speaks volumes about our dedication and resilience. Here’s why our 45 years of experience matter:

  • Stability in a shifting landscape: In an industry marked by constant change, our steadfast presence provides you with the stability you need to navigate turbulent waters confidently. We have a proven track record as a strategic partner in helping financial institutions navigate complexities and maintain a competitive edge.
  • Time-tested strategies: We’ve witnessed industry trends come and go, and our time-tested strategies reinforced with continuing education have consistently delivered results. Trust us to adapt and evolve with the times while maintaining our commitment to excellence.

Over the past 45 years, we have been a trusted partner for numerous institutions, adapting and evolving to meet their changing needs. Our longevity in the industry attests to our unwavering dedication to our clients and our ability to evolve with the changing financial landscape.

Your success simplified: Young & Associates is a full-service provider

Young & Associates offers a comprehensive suite of services designed to streamline your operations and simplify vendor management. We understand that in the fast-paced world of banking and credit unions, efficiency and convenience are paramount.

At Y&A, our offerings are not limited to a single area of expertise. When you partner with us, you gain access to a wide range of services, all under one roof. Whether you require support with regulatory compliance, lending, appraisal reviews, quality control, liquidity management, risk management and strategic planning, internal audit, information technology and cybersecurity, human resources, or training and development, we have you covered. Our clients often find value in our partnership beyond the scope of their initial engagement. They reach out for questions and seek clarifications in areas where they haven’t formally enlisted our services, trusting in our wide breadth of expertise to provide guidance and support their advancement.

By offering this holistic approach, we aim to be your trusted one-stop shop for all your financial institution’s needs. No more juggling multiple vendors – with Young & Associates, you can simplify your operations and enjoy a more efficient process. We aim to be the partner you turn to whenever an opportunity or challenge arises.

Experts with hundreds of years of combined experience

When you choose Young & Associates, you gain access to a team of consultants with centuries of collective experience in the banking and financial sector. Our consultants have been bankers themselves, giving them a unique perspective and an in-depth understanding of the challenges and opportunities specific to financial institutions. With decades of hands-on, real-world experience, our experts have walked in your shoes, gained invaluable insights, and honed their skills within financial institutions. We acknowledge that each challenge is distinct, and our diverse team possesses the expertise and proficiency required to address intricate details while harmonizing them with broader strategic considerations, ultimately ensuring your success.

High-quality, thorough work that sets Young & Associates apart

At Young & Associates, we take pride in the quality and thoroughness of our work. In the financial industry, precision can make or break your institution. Our meticulous approach ensures that no detail is overlooked, and your operations run smoothly.

Quality is the cornerstone of our services. We pride ourselves on our comprehensive approach, leaving no stone unturned in ensuring the highest standards of excellence. Our services stand out for their exceptional quality, achieved through our unyielding commitment to precision, thoroughness, and delivering actionable results.

Our sole focus is empowering financial institutions

Unlike other consulting firms with diverse portfolios, Y&A has one singular focus – financial institutions. This exclusive focus means:

  • Deep industry knowledge: We immerse ourselves in the financial sector, constantly staying ahead of industry trends and challenges to provide you with the most relevant insights and solutions.
  • Tailored solutions: Your needs are unique, and we understand that. Our exclusive focus allows us to customize our services to suit your institution’s specific requirements.

Our unwavering focus on financial institutions ensures that we possess in-depth insights into your specific challenges and opportunities. We exclusively serve banks, credit unions, and financial institutions. You can trust us to provide insights and solutions tailored to your unique needs.

Building lasting partnerships for mutual success

At the heart of our approach is a commitment to building lasting partnerships. We believe that your success is intertwined with ours, and it resonates as the success of the communities you serve. Here’s why our approach to partnerships matters:

  • Long-term vision: We’re not in it for the short haul. We’re here to support your institution’s growth and success over the long term. Our dedication centers on delivering unmatched service and expertise to empower you in generating shareholder value and enhancing the communities you serve.
  • Your goals, our mission: Your strategic objectives become our mission. We’re dedicated to helping you achieve your goals, no matter how ambitious they may be.

At Y&A, we go beyond transactional engagements; our commitment lies in forging enduring partnerships with our clients. We work collaboratively, side by side, to understand your goals and challenges. We’re dedicated to helping you achieve and exceed your financial aspirations, enabling you to better serve your communities.

Whether you’re planning for the upcoming year or envisioning your institution’s future, Young & Associates is here to provide ongoing support and guidance. With our time-tested experience, all-in-one solutions expert consultants, high-quality work, exclusive focus, and commitment to lasting partnerships, we’re your best ally in achieving success in the ever-evolving world of banking and credit unions.

Ready to discuss how Young & Associates can make a difference for your institution? Contact us today to begin a journey toward excellence and growth.

Your success simplified. Choose Young & Associates as your comprehensive partner.

6 key components of effective credit stress testing

Written by admin on . Posted in Risk Management.

When your financial institution is conducting a credit risk stress test, it’s imperative that your test has several key components for effective testing. As your trusted financial guide, at Young & Associates, we’ll walk you through the process. In this blog post, we’ll explore the key components of effective credit stress testing.  

1. Comprehensive scenario design 

This is the single most important component in creating an effective credit stress test. They say that success is 90% planning and 10% perspiration. While the exact percentages may vary, the message still stands. Planning is important! When you’re designing your credit stress scenario, be sure that you have taken into account the following:  

  • Interest rates 
  • Economic growth
  • Industry-specific risks such as collateral value of special use property 

2. High-quality data

The quality of a statistical model is only as good as the data it’s built upon. So, when you’re collecting your data, do your due diligence to ensure that it’s:  

Complete and accurate: Missing data or incorrect data will create skewed outcomes that lead to inaccurate results.  

Uniform: When you’re consolidating data from several sources, it’s important to ensure that the format and measurements are uniform over time. Be sure to test at least a few samples of the data for accuracy. 

Timely: When you’re forecasting credit stress, it’s preferable to use data from within the past 3-6 months. The economy is affected by many things, so data that is more current will more accurately reflect the current situation.  

Unique: If you’re combining data sets, it’s all too easy to get duplicates. Be sure to review the data sets to ensure that the data is not replicated elsewhere. Duplicate data can skew the results and lead to inaccurate assumptions. Examples would include property collateralizing multiple loans. It is best to consolidate these loans into one for collateral and NOI purposes. 

Relevance: Is the data that is included in the credit stress test actually relevant to the test? You may be familiar with Karl Pearson’s famous phrase, “correlation does not imply causation.” It’s good to have a working knowledge of economics so that you can draw accurate conclusions from the data and the causes for the outcome. 

3. Robust models and methodologies 

If financial institutions want to test their credit stress with integrity, it’s important that they use robust models and methodologies to measure the risk under various circumstances.  To achieve this, be sure the model you are using bases its testing on consistent data and data that is relevant to current or future economic outcomes.  

4. Adequate portfolio selection 

To obtain an accurate credit risk stress test for a specific loan portfolio (we recommend doing this), then it’s important to include a representative sample size for each segment of your portfolio (bottoms-up approach). However, if the sample size is small, Young & Associates will use call report data to back-fill the rest of the portfolio and use industry standards to stress the portfolio of loans not individually stressed (top-down approach). By including “the rest of the portfolio” Young & Associates can cover the entire portfolio without the financial institution having to gather all that data on smaller loans and accurately reflect the credit risk of your financial institution.  

5. Credit stress scenario and sensitivity 

By now, you are familiar with the preparation for a credit stress test, but another key component is the execution. What are the metrics that you’re measuring to indicate the credit risk of your bank or credit union? Credit stress tests measure several specific metrics, including credit losses, capital requirements and default rates  and the sensitivity to those risks. This highlights the metrics that heavily influence the results and can indicate the robustness of the model.

6. Risk aggregation and reporting 

Like any work, the communication of that data is just as important as the data itself. After the calculations are made, gather the outcomes and associated risks, while adding your insights for how to improve those risks. Young & Associates will go through the stress test report in detail with you and indicate issues in the report including specific borrowers that show greater risk. Young & Associates is also able to present the findings of the report to your board audit committee, and senior management if desired.   

Connect with a consultant 

Credit stress testing can sometimes feel overwhelming. We understand. Financial institutions exist to create stability for others, so when your bank or credit union is required to document the stress on your system, it can feel daunting. That’s where Young & Associates comes in. With unmatched expertise, you can trust us to guide your financial institution even when the future may seem unclear. Contact us today to learn more about our consulting and educational services.  

Meet the upcoming Fannie Mae prefunding deadline on 9/1/23

Written by admin on . Posted in Mortgage Quality Control.

Upcoming Fannie Mae prefunding deadline

Are you prepared for the upcoming Fannie Mae prefunding deadline on 9/1/23? On March 1, 2023, Fannie Mae announced changes to its selling guide that will take effect on September 1, 2023. These changes were made to improve overall loan quality and reduce the number of loans requiring remediation by lenders.

What’s changing?

As part of these changes, lenders are now required to conduct a minimum number of prefunding reviews each month. The total number of loans reviewed must meet the lesser of the following criteria:

  • 10 percent of the prior month’s total number of closings, or
  • 750 loans

Regulators encourage lenders to implement these changes immediately. They must be in full compliance by September 1.

Note: The 10 percent loan population in the September 1 – September 30 cycle will be based on the total number of loans closed in August.

How Young & Associates can assist with your pre-closing QC reviews

At Young & Associates, we understand the importance of staying ahead of the curve. With today’s downturn in mortgage loan volume and high origination costs, our independent pre-closing QC reviews can be a viable option for your organization. Let us help you navigate these changes seamlessly and mitigate the risk of noncompliance.

By conducting pre-closing Quality Control reviews, we can:

  • Provide important and timely information to origination staff prior to closing a loan.
  • Test residential mortgage loans and origination sources to identify and address loan defects prior to closing.
  • Verify that loans conform to your organization’s policies and meet insurer and guarantor requirements.
  • Mitigate the risk of noncompliance.
  • Alleviate the time and staffing issues you may be facing in today’s volatile market.
  • Control your costs by eliminating the need to maintain someone in-house to perform this work.

Why choose Y&A? Superior results at a lower cost

Young & Associates, Inc. is an industry leader and provider of QC services for over 45 years and provides mortgage quality control services to meet government-sponsored enterprise and agency requirements, including Fannie Mae. With a proven track record of delivering superior results for over four decades, partnering with us ensures that you can expect:

  • High-quality, reliable services
  • Expertise  in Fannie Mae guidelines and regulations
  • Unparalleled experience in the mortgage industry
  • Custom solutions tailored to your needs

Contact us today

Don’t let the Fannie Mae prefunding deadline catch you off guard. Reach out to Young & Associates today for professional assistance with your pre-closing QC reviews. Learn more about Y&A’s mortgage quality control services by clicking here. For more information about us and how we can assist you with your pre-closing QC reviews, contact us by phone at 330.422.3482 or email at mgerbick@younginc.com. We look forward to partnering with you to ensure compliance and success!

Assess, plan, and effectively respond to today’s market challenges

Written by admin on . Posted in Risk Management.

By: Jerry Sutherin, President & CEO

In today’s dynamic market, some of the biggest challenges faced by our clients include but are not limited to interest rate risk management, liquidity, capital adequacy, and commercial loan underwriting. These issues are magnified by the ability of our clients to locate, hire, and retain quality human capital to operate effectively and efficiently.

Interest rate risk management

Rising or fluctuating interest rates impact your financial institution’s growth prospects in both the short and long term. Not only do interest rates pose a risk to a financial institution’s balance sheet, but they also impede the ability to effectively produce reliable financial statement forecasts. A financial institution’s Net Interest Margin (NIM) is a key component of each income statement. Being able to adequately forecast interest income as well as internal cost of funds allows an institution to produce a reliable budget. To overcome this, financial institutions must identify, measure, monitor, and control interest rate risks to meet the requirements of the Joint Policy Statement on Interest Rate Risk (IRR) and the IRR regulatory guidance. Effective control of the interest rate risk will require conducting annual independent reviews of the asset liability management (ALM) function and validating your risk measurement systems to ensure their integrity, accuracy, and reasonableness. This will also involve internal controls of loan and deposit pricing. Establishing and maintaining these controls should begin at the board level and flow through management.

Credit risk management

Rising interest rates have also had a profound impact on credit quality of commercial lending. (One of the primary drivers of revenue for most financial institutions). The change in credit quality results in the tightening of credit standards throughout the industry and by the regulators. Being able to effectively underwrite loans and mitigate risks within a commercial loan portfolio is a function of having seasoned staff to manage these processes. Lack of quality credit talent exposes financial institutions to otherwise preventable credit risks. The dilemma for most financial institutions is finding, hiring, and maintaining experienced personnel. In some instances, this has resulted in inadequate credit presentations being prepared by unqualified individuals or loan officers underwriting their own credits for approval. The increasing burden of inflation and wages adds another layer of complexity to the mix. Many community-focused institutions are not willing or able to pay top rate for talent. This is understandable given the need and focus to remain competitive among the larger regional and national banks.

Liquidity risk management

Another impact of a higher interest rate environment and inflation is the disintermediation of funds or liquidity from financial institutions to other financial intermediaries. Sound liquidity management is crucial for controlling your organization’s liquidity risk and managing cash flow to meet expected and unexpected cash flow needs without adversely affecting daily operations. Your financial institution should assess the range of possible outcomes of contemplated business strategies, maintain contingency funding plans, position for new opportunities, and ensure regulatory compliance and the adequacy of your risk management practices.

Capital planning

Both interest rate risk management and liquidity management have a direct impact on the capital adequacy of all financial institutions. Capital contingency planning will ensure that your financial institution maintains the required level of capital through any realistic stress event. Periodic review of minimum capital requirements and stress tests can provide valuable insights. They will also maintain your standing with the regulators.

The importance of strategic planning

So far, this article has only discussed the challenges faced by the financial institution industry. These obstacles are not just management issues. They are also issues that boards of directors must navigate as well.

Are there solutions? Absolutely — yes there are. Boards of directors and management must be aligned on all strategic initiatives. These objectives need to be derived and adopted by the board and conveyed to management. The most common approach is through a focused strategic planning session involving the board and management. The outcome of such a retreat will enable the board to identify goals and risks faced by the organization. It also helps decide how to accomplish the goals and mitigate the risks. This could be through the utilization of qualified internal staff or engaging outside experts to assist with each objective. An effective strategic plan will incorporate all these pieces to help navigate the changing industry landscape.

More about Y&A

For 45 years, Young & Associates has partnered with banks and credit unions across the country. We provide consulting, outsourcing, and educational services to minimize their risk and maximize their success. Our services cover areas such as interest rate risk analysis, liquidity planning, assessment of capital adequacy strategic planning, regulatory assistance, internal audit, independent loan review, IT audits and penetration testing, and regulatory compliance assessment, outsourcing and training. Our team of consultants boasts an unmatched level of industry experience and is comprised of former banking executives, compliance regulators, and tenured finance professionals who have personally experienced many of the same issues you face at your organization.

More about Y&A Credit Services

For commercial credit needs, Y&A Credit Services is a full-service provider of outsourced underwriting services and credit analysis. An independent entity, Y&A Credit Services offers the same exceptional service, expertise, and integrity you’ve learned to expect from Young & Associates. Y&A Credit Services provides commercial credit underwriting and credit approval presentations, annual underwriting reviews, financial statement spreading and analysis, and approval and underwriting package reviews. We’ll work to improve the quality, speed, and accuracy of your lending with a focus on minimizing your credit risk. Our team members are experts in credit services and the financial industry. Our team includes former chief credit officers and senior credit analysts from both community and regional banks. We provide full outsourced credit department services to our clients, keeping their costs low. This helps these institutions remain competitive in their markets. Our seasoned credit professionals boast a combined more than 100 years of experience in credit administration. Our experts help mitigate risks while assisting our clients with safe and sound underwriting processes.

Partner with us for success

We look forward to assisting your bank or credit union in meeting these challenges head on. Contact us directly by emailing Jerry Sutherin, President & CEO, at jsutherin@younginc.com or calling him directly at 330.422.3474

Ensuring compliance in a BSA/AML compliance program: Independent testing

Written by admin on . Posted in Compliance & Regulations.

By: Edward Pugh, AAP, CAMS, CAMs-Audit, CFE

One of the key components of a financial institution’s compliance with BSA/AML regulatory requirements is independent testing of the BSA/AML Program. Independent testing may be performed by an institution’s internal audit department, outside auditors, consultants, or other qualified independent parties. There is no regulatory requirement establishing the frequency of BSA/AML independent testing; rather, the frequency should be commensurate with the money laundering/terrorism financing risk profile of the institutions. Many institutions conduct independent testing every 12 to 18 months, increasing frequency if there are any significant changes in the risk profile, such as changes in systems, compliance staff, products, mergers/acquisitions, or an institution’s size. Significant errors or deficiencies may also warrant more frequent independent testing to validate mitigating or remedial measures.

Often, the need for a truly independent assessment, combined with limitations in staffing capacity, prompts institutions to engage an external entity to conduct a comprehensive evaluation of their BSA/AML program compliance. Thus, it is critical to ensure that the independent review provides an unbiased assessment of an institution’s BSA/AML compliance efforts, identifies potential risks or weaknesses, and offers recommendations for improvement. Some key components of a satisfactory BSA/AML independent program audit or testing include the following:

  • Scoping and planning: The scope of the review should be based on a risk assessment of the institution’s products, services, customers, and geographic locations. The scoping and planning phase often relies on the institution’s own BSA/AML risk assessment, but if it is inadequate, the external auditor may determine the scope. Additionally, any changes in the business or regulatory environment, as well as any issues identified in previous audits or examinations, should be taken into account.
  • Independence: The audit/testing should be conducted by individuals who are independent of the BSA/AML compliance program. While internal auditors may be acceptable, a BSA Officer or assistant would not be. This ensures that any findings are objective and unbiased.
  • Qualifications and training of auditors: Persons conducting the independent testing should have sufficient knowledge and understanding of the BSA, AML, and related regulations. They should be trained in auditing principles and procedures and understand the various risks financial institutions face.
  • Review of the BSA/AML compliance program: The audit should include a comprehensive review of the BSA/AML Compliance Program, including its policies and procedures, risk assessment, internal controls, training programs, and the role and performance of the BSA Officer.
  • Transaction testing: Thorough transaction testing should be conducted to verify compliance with BSA/AML requirements, such as customer identification, suspicious activity reporting, customer due diligence, currency transaction reporting, and record keeping requirements.
  • Assessment of training programs: The institution’s BSA/AML training programs should be reviewed to ensure they are adequate, up-to-date, and effective in educating employees about the BSA/AML responsibilities. The Board of Directors training should also be reviewed.
  • Reporting: An audit report should be produced that clearly communicates findings, including any weaknesses or deficiencies in the compliance program. Appropriate recommendations for improvement should also be provided where necessary.

A comprehensive and effective BSA/AML independent program audit is essential for financial institutions to ensure compliance with the various laws and regulations pertaining to BSA/AML. Some issues pertaining to independent testing that are frequently found in Reports of Examination include lack of independence on the part of the auditor(tester), insufficient scope, and insufficient transaction testing. A comprehensive and independent audit of an institution’s BSA/AML compliance program not only facilitates regulatory adherence, but also pinpoints and highlights any existing program deficiencies.

Additional Resources: FFIEC BSA/AML Assessing the BSA/AML Compliance Program – BSA/AML Independent Testing

Young & Associates works with financial institutions of all sizes to help them avoid regulatory pitfalls and develop strong BSA/AML compliance programs. For more information, contact me at epugh@younginc.com or 330.422.3475.

The role of loan review in the credit risk management system

Written by admin on . Posted in Risk Management.

By: David Reno, Director of Loan Review & Lending Services

Loans, especially non-consumer loans, typically represent the greatest level of risk on your balance sheet. Therefore, effective commercial loan portfolio management is crucial to control credit risk. It can serve as an early indicator of emerging credit risk related to lending to individual borrowers, aggregate credit exposure to related borrowers, and the overall credit risk associated with a loan portfolio. It serves as an integral part of an institution’s credit risk management system that is a continuum comprised of the following stages:

  • Well-formulated lending policies, procedures, and practices that are consistently applied, well-known to all credit and lending staff, and compliant with regulatory guidance
  • The collection and accurate credit analysis of financial and other underwriting information
  • Assignment of an accurate risk grade
  • Proper and qualified approval authorities and risk-based process
  • Correct and thorough documentation
  • Pre-closing preparation and loan closing
  • Post-closing credit administration
  • Internal annual loan review
  • External/independent loan review
  • Timely problem loan identification and management
  • Proper calculation of the ALLL
  • Collection and loss mitigation

Effective and efficient loan reviews can help an institution better understand its loan portfolio and identify potential risk exposures to contribute to the formulation of a risk-based lending and loan administration strategy.

Regulatory background

The OCC, FRB, FDIC, and NCUA issued the Interagency Guidance on Credit Risk Review Systems in FIL-55-2020 dated May 8, 2020, which aligns with Interagency Guidelines Establishing Standards for Safety and Soundness. This guidance is relevant to all institutions supervised by the agencies and replaces Attachment 1 of the 2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses. The final guidance details the objectives of an effective credit risk review system and discusses such topics as sound management of credit risk, a system of independent, ongoing credit review, and appropriate communication regarding the performance of the institution’s loan portfolio to its management and board of directors.

Credit risk rating (or grading) framework

The foundation for any effective credit risk review system is accurate and timely risk ratings. These risk ratings are used to assess credit quality and identify or confirm problem loans. The system generally places primary reliance on the lending staff to assign accurate, timely risk ratings and identify emerging loan problems. However, the lending personnel’s assignment of risk ratings is typically subject to review by qualified and independent peers, managers, loan committee(s), internal credit review departments, or external credit review consultants that provide a more objective assessment of credit quality.

Elements of an effective credit risk review system

The starting point is a written credit risk review policy that is updated and approved at least annually by the institution’s board of directors or board committee to evidence its support of and commitment to maintaining an effective system. Effective policies include a description of the overall risk rating framework and responsibilities for loan review.

An effective credit risk review policy addresses the following elements:

Qualifications of credit risk review personnel. The level of experience and expertise for credit risk review personnel is expected to be commensurate with the nature of the risk and complexity of the loan portfolio, and they should possess a proper level of education, experience, and credit training, together with knowledge of generally sound lending practices, the institution’s lending guidelines, and relevant laws, regulations, and supervisory guidance.

Independence of credit risk review personnel. Because of their frequent contact with borrowers, loan officers, risk officers, and line staff are primarily responsible for continuous portfolio analysis and prompt identification and reporting of problem loans to proactively identify potential problems. While larger institutions may establish a separate credit review department, smaller institutions may use an independent committee of outside directors or other qualified institution staff. These individuals should not be involved in originating or approving the specific credits being assessed, and their compensation should not be influenced by the assigned risk ratings. Regardless of the approach taken, it is prudent for the credit risk review function to report directly to the institution’s board of directors or a committee thereof. Senior management should be responsible for administrative functions.

The institution’s board of directors may outsource the role to a third-party vendor; however, the board is ultimately responsible for maintaining a sound credit risk review system.

Scope of reviews

Comprehensive and effective reviews cover all segments of the loan portfolio that pose significant credit risk or concentrations. The review process should consider industry standards for credit risk review coverage, which should be consistent with the institution’s size, complexity, loan types, risk profile, and risk management practices. This consideration helps to verify whether the review scope is appropriate.

An effective scope of review is risk-based and typically includes:

  • Loans over a predetermined size along with a sample of smaller loans
  • Loans with higher risk indicators, such as low credit scores or approved as exceptions to policy
  • Segments of loan portfolios, including retail, with similar risk characteristics, such as those related to borrower risk (e.g., credit history), transaction risk (e.g., product and/or collateral type), etc.
  • Segments of the loan portfolio experiencing rapid growth
  • Past due, nonaccrual, renewed, and restructured loans
  • Loans previously criticized or adversely classified
  • Loans to insiders, affiliates, or related parties
  • Loans constituting concentrations of credit risk and other loans affected by common repayment factors

 Review of findings and follow-up

A discussion of credit risk review findings should be held with management, credit, and lending staff and should include noted deficiencies, identified weaknesses, and any existing or planned corrective actions and associated timelines.

Communication and distribution of results

The results of a credit risk review are presented in a summary analysis with detailed supporting information that substantiates the concluded risk ratings assigned to the loans reviewed. The summary analysis is then periodically presented to the board of directors or board committee to maintain accountability and drive results. Comprehensive reporting includes trend analysis regarding the overall quality of the loan portfolio, the adequacy of and adherence to internal policies and procedures, the quality of underwriting and risk identification, compliance with laws and regulations, and management’s response to substantive criticisms or recommendations.

Summary insights

The back-testing that is performed by the loan review process is necessary to ensure that an institution has in place a comprehensive and effective credit risk management system and that an institution acknowledges and practically applies the established framework of its unique but compliant credit culture.

An effective external loan review process is not so much a traditional audit exercise as it is an advisory process that produces meaningful dialogue between the review firm and the institution that seeks to identify and interpret various aspects of credit risk to minimize risk of loss by implementing industry best practices, maintaining regulatory compliance, and supporting the institution’s long-term viability in continuing to serve the needs of its customers and community.

For more information on the role of loan review in the credit risk management system, contact David Reno. Reno is the director of loan review & lending services, at dreno@younginc.com or 330.422.3455.

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