Magazine article The Journal of Lending & Credit Risk Management

A Look at House Limits

Magazine article The Journal of Lending & Credit Risk Management

A Look at House Limits

Article excerpt

Portfolio growth over the past several years caused First Liberty Bank to examine the relationship between house lending limits and legal lending limits. As the bank began this analysis, it attempted to determine the industry standard for calculating house lending limits. This article describes the research that accompanied this effort and conclusions that may be drawn from the findings.

"Old-timers" may recall the period ending in the early to mid-1970s as a time predating credit officers as we think of them today. It was a time during which most banks vested loan approval on the line side of the bank. In many institutions that sought to control the credit approval process, the ultimate approving authority was commonly the loan committee, usually chaired by the senior loan officer. In some institutions, senior lenders had the ability to grant legal limit loans to a single borrower. Loans were underwritten in a much more liberal atmosphere and without the current systems of internal quality controls and independence. such concentrations of credit risk were one of the contributing factors to the banking crisis of the early 1970s.

The concept of a "house limit," as opposed to the statutorily defined legal lending limit, therefore, probably dates to the mid-1970s. To be sure, some banks had this tool in place before that time, but the concept of limiting the amount of credit available to a single borrower to a level more restrictive than is legally required did not become commonplace until much later. The pressure to establish lower credit limits often came from the various examination agencies that "encouraged" bank management to consider self-imposed lending limits as a portfolio risk management tool. House limits served to avoid an unduly high concentration of credit exposure to a single borrower - a key element in the problems of this earlier era.

As First Liberty began to study the relationship between its house and legal limits, the bank attempted to tap into the base of available data that might reveal the standard practices within the industry. Armed with such knowledge, the bank hoped to incorporate the industry's best practices into its own model of what the internal lending limit should be.

Following a fruitless search, it became evident that no such standard existed. There had been some internal discussions on this issue among the banking regulators, and many banks in the U.S. and Canada had wrestled with the issue individually. However, there was no standard within the industry to guide First Liberty in its deliberations.

Consequently, the bank turned to the network and contacts available through RMA - dozens of institutions across the country - to see how they approached this problem. Data were analyzed from larger banks ([greater than]$10 billion in assets), mid-sized banks ($1-$10 billion in assets), and smaller banks ([less than]$1 billion in assets). While not scientific in its approach, this grouping did point out the various levels of formality involved as banks of different size wrestled with this issue. The results were very interesting.

Larger Institutions Had Most Formal Approach

As might be expected, the larger institutions, which typically have more refined credit systems, had the most formal approach to the issue of house limits. Typical in the larger institutions was a tiered approach using a bank's internal loan pass grades for its tiers. For purposes of illustration, in an institution with five pass grades, the house limits were frequently stratified in the following manner:

Loan Grade 1    50% of legal limit
Loan Grade 2    40% of legal limit
Loan Grade 3    30% of legal limit
Loan Grade 4    20% of legal limit
Loan Grade 5    10% of legal limit

Interestingly, the ranges within risk grade varied widely among the banks surveyed - from a high of 75% to a low of 32% of the legal limit for Grade 1 facilities. In the Grade 5 tier, the ranges were from a high of 15% to a low of just 4% of the legal limit. …

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