Whether for the purpose of approval or for after-the-fact review, most banks have credit committees. Whatever its purpose, the credit committee serves as a forum for the bank's senior lenders to interpret lending policy, educate their junior lenders, and thereby shape the bank's credit culture.
As credit quality issues have come to the forefront in recent years, many banks have reevaluated and altered their committee/review processes. Others are reexamining their processes now and are likely to make changes. The format in which credit committees review loans should be a part of the reevaluation exercises.
It is not surprising that the format of credit committee write-ups varies widely from bank to bank. They are usually the cumulative result of informational needs and priorities as perceived by the bank's credit administrators. Sometimes the format outlives those who originally created it, and the bank needs to ask whether that format is serving its intended purposes. If it is not, would standardizing it to create a consistent format help ensure that the credit committee can meet its objectives?
Although standardization has worked well at my bank, my purpose is not necessarily to advocate standardizing but to stimulate thought as this issue is examined at other banks.
Inherent in all credits are subjective and objective factors, both of which bear on the borrower's creditworthiness. Subjective factors include issues such as:
* The reputation, integrity, and competence of the borrower.
* The relative risk associated with the borrower's industry.
* An evaluation of the borrower's past relationship with the bank.
These are factors that need to be addressed both in the approval process and in the annual review process and that require a detailed write-up by the loan officer. The subjective part of the write-up defies much standardization except for the points that should (or must) be covered. The results depend on the writing skills of the loan officer.
Objective elements of the credit are a different matter, however, and it is not difficult to compile a list of them. Several examples will help define the nature of these elements.
* Exact payment terms - interest payment frequency, principal reduction schedule, amortization period, balloon payments, renewal options.
* Collateral structure - how many shares, acres, or units are pledged? what are the margin requirements? who holds the collateral? are there any prior liens? what are the terms of prior liens, the terms of any sharing arrangements with other lenders, the terms under which the collateral structure can be modified, and the cross-pledge arrangements? What are the collateral valuation source, and the date and amount of last appraisal?
* Support structure - guarantee limitations, buy-back terms, partner liability or lack thereof.
* Origination date (the real origination date, not just the most recent renewal date).
* Original payment terms.
* Original purpose.
The list can be quite long and can cover aspects of the credit that might seem to be strictly mechanical. So why so much attention to these aspects of credit extension?
Two Ways to Lose
There are two excellent ways to lose money in the lending business, and many banks virtually perfected them in the 1980s.
The first way is to ignore your own underwriting guidelines. Take a close look at them, and you find that many, if not most of them, are mechanical in nature. These guidelines include:
* Equity/margin requirements.
* Repayment constraints.
* Financial reporting requirements.
* Documentation of cash flow.