Jeff Judy

Jeff's Thoughts - December 3, 2014

Monitor Your Monitoring

In this edition of Jeff's Thoughts, my colleague Jim Lohn brings his long experience in credit review to bear on the challenge of detecting slippage in sound credit practices during times of loan growth. More about Jim below.

After 40+ years of dealing with bank lending functions from every possible perspective -- as lender, approver, and borrower, through documentation, credit support and loan review and examination -- in several hundred institutions across this wide country, I have seen lots and lots of portfolios through several economic cycles. That has given me ample opportunity to see where things start to slip, where sound practices tend to loosen up, under pressure to grow the credit business.

I have always heard that loan underwriting was the first thing to show deterioration in times of loan growth or economic boom. But I have found that underwriting is the second thing to slip. The time it takes to develop new business has to be diverted from somewhere, and I believe that the first place to suffer from this diversion is loan monitoring.

What is loan monitoring? And why does it matter? Loan monitoring includes all those good things that lenders or relationship managers do to stay on top of their credits. That means phone calls to see how things are going, it means obtaining financial statements, rent rolls, occupancy data. It is doing inspections on RE, doing covenant checks, and doing valuations on collateral of whatever type. It includes following up on leases. It is getting filing, spreading and analysis done.

When we see the first signs of slippage in underwriting, we find them easy to dismiss: "We rarely do that" or "That was what the competition offered" or "That was an approved exception".

But slippage in loan monitoring is more deadly. When lenders or relationship managers are busy developing new business, it is easier to let loan monitoring slide.

How does one tell whether loan monitoring has slipped? It could be a stack of filing that hasn't been handled. It could be credits blowing up that are surprises to the officer and management. But mostly, what I see is more statement exceptions, fewer inspections, items left unresolved like covenant violations. These are often soft measurement areas, not always well documented. But if I inquire why they aren't done, I hear that the lender has been so busy trying to get these two deals or loans booked that monitoring has had to take a back seat for the moment.

When things slip in loan monitoring, more "surprises" occur. The problem is that these surprises are never the positive kind. They are universally negative. So keep an eye on the status of loan monitoring. Some banks have tickler systems that include these types of duties. But they only work if you pay attention to the tickler reports.

Remember that proper loan monitoring serves many purposes, but the biggest one is finding problems before they get too bad. This gives the institution many more options in how to resolve the issues. It may even help the institution to help customers in their businesses, which really cements relationships. Every seasoned lender has stories about how they brought something to the attention of a borrower or business, only to find that years later the borrower thanked them for "saving" their business.

Yes, it is always important to keep an eye on underwriting.

But my long experience tells me that you can detect - and fix -- slippage in sound credit practices earlier, and head off more painful surprises, by monitoring your monitoring and responding quickly and firmly to slippage.

About Jim Lohn

Jim is a seasoned and respected credit manager, who after 43 years on all sides of the lending desk now runs Loan Review Associates in Renton, WA. Jim served on credit boards of large banks, on the SBA advisory council, was an OCC lead credit Expert and holds Credit certification from RMA and BAI. He can be reached at james@loanreviewassociates.com