Pub. 5 2017 Issue 2

18 The Community Banker www.mibonline.org “The OCC reported that 2016 was the 4th consecutive year of underwriting leniency among 93 national banks and federal savings associations it reviewed. So, to stay fiscally fit and avoid running into problems with credit issues (even if minor), bankers should be preparing now.” A lthough it is always a good time to review your credit guidelines, now may be an especially good time to do it. As the rate environment changes, you may find original scenarios changing along with the risk al- lowances. Knowing that, it would be prudent to review your credit rules to ensure that you are op- timizing your opportunities and minimizing your risk. Although every banker knows what to look for, here are a few things to keep in mind. Capture Pre-payment Penalty Income There is a built-in way to provide you with pre-payment penalty income which should be captured. The standard clause ensures that if a borrower pays off more than 20% of the principal balance per year, there is a penalty fee due. Remember that this is not cumulative, but year by year. This is considerable income if the borrower wants to refinance at another bank or simply pay off the loan. However, oftentimes this penalty option is turned off or it is waived. The pre-payment clause in your core documentation system should be reviewed. If you feel that the standard penalty clause is not competitive, then it is always customizable for your market. This is an area to review before processing your loans since it is an easy area to recover fees and increase income. Stress Test at the Loan and Portfolio Level You will want to stress test robustly both at the loan and portfolio level. The testing should take one day with the correct tools, and it should be done quarterly to ensure that any changes do not negatively impact the bank’s bottom line. Once you have the data, it should also be applied to capital to surface trends in capital adequa- cy. Regular stress testing and review help protect the bank and provide an opportunity to take additional action if capital levels appear to be heading in the wrong direction. Update Loan Information Regularly Next, consider that when you are doing stress testing, frequen- cy is important but so is the regular update of loan infor- mation. Keeping data current, including additional owners, change in owners’ information and the value of underlying property (in the event of major market changes, re-zoning or renovations) for example, helps ensure your results are up-to- date and can be leveraged better. Debt service coverage ratios should be updated at least once per year to ensure continuing loan performance. Too often we see that once a loan is approved and funded, it is forgotten unless there are problems. Keep your systems up-to-date to have the best data available. Stress Test New Loans up to 400bp Consider that new loans should also be interest rate stress tested up to 400bp when under- writing them. This is good regular practice to understand risks and exposures, but with the relative- ly low rate environment, it has been tempting to let this slide. Bankers should revisit this and also consider adding a few other important factors such as cash flow, LTV, loan type, guarantor strength (more on this next) and industry. Remember Contingent Liability Contingent liability is an important element of underwrit- ing. Look at the guarantor to see what other debt they may have through other property loans, lines of credit etc. If there are oth- er loans held by the guarantor, due diligence should be carried out to find out when those are due and how much they owe on a global basis. Ask whether a higher rate environment will re- sult in problems with these loans as you underwrite the latest one for consideration. The OCC reported that 2016 was the 4th consecutive year of underwriting leniency among 93 national banks and federal savings associations it reviewed. So, to stay fiscally fit and avoid running into problems with credit issues (even if minor), bankers should be preparing now. It is a good time and a good idea to review your underwriting practices and stress testing measures to be sure they work in the current environment. Steve Brown has over 30 years of banking and capital markets experience, is frequently quoted in the press on banking issues and trends and is a regular speaker at industry conferences. He is also the author of the popular Banc Investment Daily. For more information, please visit www.pcbb.com . CREDIT REMINDERS – NOW IS THE TIME TO REVIEW By Steve Brown, President & CEO PCBB