Course: Loan Portfolio Management

Loan Portfolio Management Table of Contents Overview

………………………………………………………………………………………. 1 Risks Associated with Lending
………………………………………………………….. 3 Credit Culture and Risk Profile
………………………………………………………… 11 Loan Portfolio Objectives
………………………………………………………………. 13 Strategic Planning for the Loan Portfolio
…………………………………… 13 Financial Goals ……………………………………………………………………. 14 Risk
Tolerance …………………………………………………………………….. 15 Portfolio Risk and Reward
………………………………………………………………. 15 The Loan Policy
……………………………………………………………………………. 17 Loan Policy Topics
……………………………………………………………….. 19 Loan Approval Process
…………………………………………………………. 20 Portfolio Management
…………………………………………………………………… 22 Oversight
……………………………………………………………………………. 22 Risk Identification
……………………………………………………………….. 22 Nonaccrual Status
………………………………………………………………… 24 Exceptions to Policy, Procedures, and Underwriting
Guidelines …… 25 Documentation Exceptions ……………………………………………….. 25 Policy and
Underwriting Exceptions……………………………………. 26 Aggregate Exception Tracking and Reporting
……………………………. 27 Portfolio Segmentation and Risk Diversification ………………………… 28 Identifying
Concentrations of Risk ………………………………………. 28 Evaluating and Managing Concentrations of Risk
………………………. 30 Concentration Management Techniques ……………………………… 31 Stress Testing
……………………………………………………………………………….. 32 Allowance for Loan and Lease Losses
……………………………………………….. 33 Credit Management Information Systems
………………………………………….. 34 Collections and Work-out ……………………………………………………………… 35
Lending Control Functions ……………………………………………………………… 37 Independence
……………………………………………………………………… 37 Credit Policy Administration
………………………………………………….. 38 Loan Review ……………………………………………………………………….. 38
Audit …………………………………………………………………………………. 39 Administrative and Documentation
Controls …………………………….. 39

Loan Portfolio Management Supervision …………………………………………… 41 Asset Quality Reviews

…………………………………………………………… 41 Targeted Reviews …………………………………………………………………
42 Process Reviews ………………………………………………………………….. 42 Administrative and Documentation
Reviews …………………………….. 43 Compliance Reviews……………………………………………………………. 43 Follow-
up Evaluations on Management Commitments ……………….. 43 Ongoing Supervision
……………………………………………………………. 43

30 Class Hours

Instructor: Scott Enongene

Lending is the principal business activity for most commercial banks. The loan portfolio is typically the
largest asset and the predominate source of revenue. It is also the greatest source of risk to a bank’s
safety and soundness. Loan portfolio management is the process by which risk inherent in the lending
process are managed and controlled.

This 5-day course will introduce participants to the framework of credit risk management. They will
learn how to identify the various types of risk and techniques and tools for mitigating this risk.

The course will also provide an understanding of the various measuring, monitoring and stress testing
reports that are available to help understand and manage concentration risk, and how to identify
concentration risk in a bank’s portfolio.

Students will learn how to identify the credit culture within their institution, develop a risk appetite
statement for their bank and ways to improve the credit risk management practices at their institution.

At the conclusion of this course, the student will be able to:

Identify the types of risk within the loan portfolio

Identify their bank’s credit culture

Develop a risk appetite statement for their institution

Determine a risk strategy/profile for their institution

Understand techniques for measuring, monitoring and stress testing the portfolio

Understand the impact their loan policy will have on the portfolio

Establish risk based capital limits for individual asset classes

Identify concentration risk within a portfolio

Analyze the benefits and drawbacks from risk diversification and risk concentration

Utilize best practices for concentration risk management

Recognize when a loan needs to go to a workout

Prepare the student for a change in the credit cycle, and the impact it could have on their institution.

Overview Introduction Lending is the principal business activity for most commercial banks. The
loan portfolio is typically the largest asset and the predominate source of revenue. As such, it is
one of the greatest sources of risk to a bank’s safety and soundness. Whether due to lax credit
standards, poor portfolio risk management, or weakness in the economy, loan portfolio problems
have historically been the major cause of bank losses and failures. Effective management of the
loan portfolio and the credit function is fundamental to a bank’s safety and soundness. Loan
portfolio management (LPM) is the process by which risks that are inherent in the credit process
are managed and controlled. Because review of the LPM process is so important, it is a primary
supervisory activity. Assessing LPM involves evaluating the steps bank management takes to
identify and control risk throughout the credit process. The assessment focuses on what
management does to identify issues before they become problems. This booklet, written for the
benefit of both examiners and bankers, discusses the elements of an effective LPM process. It
emphasizes that the identification and management of risk among groups of loans may be at
least as important as the risk inherent in individual loans. For decades, good loan portfolio
managers have concentrated most of their effort on prudently approving loans and carefully
monitoring loan performance. Although these activities continue to be mainstays of loan portfolio
management, analysis of past credit problems, such as those associated with oil and gas lending,
agricultural lending, and commercial real estate lending in the 1980s, has made it clear that
portfolio managers should do more. Traditional practices rely too much on trailing indicators of
credit quality such as delinquency, nonaccrual, and risk rating trends. Banks have found that
these indicators do not provide sufficient lead time for corrective action when there is a systemic
increase in risk.

Effective loan portfolio management begins with oversight of the risk in individual loans. Prudent
risk selection is vital to maintaining favorable loan quality. Therefore, the historical emphasis on
controlling the quality of individual loan approvals and managing the performance of loans
continues to be essential. But better technology and information systems have opened the door
to better management methods. A portfolio manager can now obtain early indications of
increasing risk by taking a more comprehensive view of the loan portfolio. To manage their
portfolios, bankers must understand not only the risk posed by each credit but also how the
risks of individual loans and portfolios are interrelated. These interrelationships can multiply risk
many times beyond what it would be if the risks were not related. Until recently, few banks
used modern portfolio management concepts to control credit risk. Now, many banks view the
loan portfolio in its segments and as a whole and consider the relationships among portfolio
segments as well as among loans. These practices provide management with a more complete
picture of the bank’s credit risk profile and with more tools to analyze and control the risk. In
1997, the OCC’s Advisory Letter 97-3 encouraged banks to view risk management in terms of the
entire loan portfolio. This letter identified nine elements that should be part of a loan portfolio
management process. These elements complement such other fundamental credit risk
management principles as sound underwriting, comprehensive financial analysis, adequate appraisal
techniques and loan documentation practices, and sound internal controls. The nine elements are:
• Assessment of the credit culture, • Portfolio objectives and risk tolerance limits, • Management
information systems, • Portfolio segmentation and risk diversification objectives, • Analysis of loans
originated by other lenders, • Aggregate policy and underwriting exception systems, • Stress
testing portfolios, • Independent and effective control functions, • Analysis of portfolio risk/reward
tradeoffs.
Each of these elements is important to effective portfolio management. To a greater or lesser
degree, each indicates the importance of the interrelationships among loans within the portfolio.
Their focus is not on individual transactions, but on a group of similar transactions and on
verifying the integrity of the process. Each practice, by itself, adds a dimension to loan portfolio
management, but their value is amplified when they are used together; moreover, the absence
of any one of these elements will diminish the effectiveness of the others. These elements are
described in greater detail in appendix C and throughout the introductory section of this booklet.
All banks need to have basic loan portfolio management principles in place in some form.
However, the need to formalize the various elements discussed in this booklet, and the
sophistication of the process, will depend on the size of the bank, the complexity of its portfolio,
and the types of credit risks it has assumed. For example, a community bank may be able to
implement these principles in a less formal, less structured manner than a large bank and still
have an effective loan portfolio management process. But even if the process is less formal, the
risks to the loan portfolio discussed in this booklet should be addressed by all banks. The
examiner assigned LPM is responsible for determining whether the bank has an effective loan
portfolio management process. This includes determining whether the risks associated with the
bank’s lending activities are accurately identified and appropriately communicated to senior
management and the board of directors, and, when necessary, whether appropriate corrective
action is taken.