Madison Associates LLC

According to Omega Performance’s 2012 Banking Trends Outlook Survey, banks have made specific goals to increase the amount of lending in the commercial arena. In fact, 77% of US banks stated they plan to increase their small business lending in 2012. The survey gave an overall feeling that bankers worldwide believe the economy will continue to improve through 2012.  This brings welcome news in contrast to the SBA’s Office of Advocacy reports of an almost 7% decrease in small business loans since 2010.

What this positive outlook also brings is a need for commercial loan review enhancements. With the possible Nearly 92% of survey respondents stated that their priorities will lie in adding and improving training.

A commercial loan review that is proactive in its approach to an entire portfolio as well as informative to its users can prevent issues from going unseen until it becomes too late. Banks will need to take the lessons learn from the past 5 years and adapt their actions based on maintaining satisfactory accounts. 

Many organizations are working to establish a more extensive review process for commercial loan reviews while others are choosing to outsource the work to specialist. Either way, the availability of third party resources as well as emerging software is helping to create a comprehensive approach to protecting bank safety and soundness.

Commercial loan administration today is a much more complicated process than in the past, especially when applied to commercial real estate loans. Valuing the underlying real estate requires more careful analysis.

In the past, some lending portfolio managers would simply ensure that a property’s new net operating income is adequate to meet their bank’s debt service coverage ratio requirement. More detail oriented lenders might even go as far as to recalculate the property’s value based on an updated NOI and a market capitalization rate.

Today, though, good commercial loan administration requires a much deeper look at a property and its operations. Astute managers will carefully analyze a property’s rent roll and go well beyond simply calculating NOI. To begin with, they will assess each tenant’s likelihood of remaining in the property and their ability to meet their obligations. The next step is to carefully analyze the rent levels to ensure that they are replaceable in the market. For example, if a tenant has two years remaining on a lease at $27 per square foot when the market is now $18 per square foot, the building is likely to lose income in a couple of years.

Paying attention to these factors and building property valuations that take

future changes into effect can make a significant difference in a bank’s bottom line. Knowing what is likely to come down the line can help credit departments position themselves for work outs with borrowers or, if necessary, conserve capital to increase their reserve accounts.

Risk Management Systems Support

In today’s increasingly complex financial world, banks involved in commercial lending or commercial loan risk management need to regularly reassess whether their processes and systems adequately provide the support and control that they need.  Lenders need to be able to assess at a moment’s a multitude of issues with the ability to take management action, such as:

• Documentation of lending authority by individual and/or group  
• Lending levels, limits, limit compliance and controls
• Lending activity by product type, business type, loan type or loan size.
• Geographic distribution of lending so that the needs of the community are met within the risk standards established by your organization.
• Current customer financial information including current financial statements, tax returns, credit reports.
• Collateral value in relation to exposure.
• Maintenance of collateral coverage requirements such that assets held as collateral are adequate.
• Guidelines for loan participations and reporting aggregate participations related to specific borrowers, categories, geographic areas and lead originators.
• Off balance sheet items including committed but undisbursed loans, letters of credit or issues of securitized instruments have become a more serious issue as the markets have changed.

Commercial loan portfolio risk management has become a more complex problem for managers especially as regulations have increased over the last decade, making your job more difficult.   Risk management has become an activity that requires solid technical help.  A well thought out business process and software solution can make your job easier and more effective.

The sweeping 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act was enacted in response to the worst financial crisis since the Great Depression. Among the legislation’s principal provisions are several giving federal bank regulators greater power to identify and deal decisively with financially troubled banks before their problems threaten the entire financial system.

One tool the regulators now have is the so-called “stress test”, which is designed to gauge banks’ ability to withstand a future economic downturn as severe as any in U.S. history.   Earlier this year, nineteen of the nation’s largest commercial banks, which hold more than half of the nation’s total assets, were subjected to the initial round of testing. The rigorous “enterprise wide” process required thousands of agency and bank staff hours and involved aspects of the banks’ operations from commercial loan portfolio risk management to maintenance of adequate liquidity.

Some 7,000 other commercial banks, including many community institutions with assets of $10 billion or less, closely observed the process. Many community bank executives and trade associations questioned whether their institutions would – or should – be subjected to the same intensive scrutiny as their larger cousins. They asserted that they are already complaint with commercial lending regulations, follow “state of the art” commercial loan administration procedures and practice sound consumer and commercial loan risk management. They also noted that the expense of a full stress test would be burdensome and disproportionate to the risk.   

In May, the federal bank regulators responded with a “clarification of supervisory expectations”, assuring smaller banking organizations that they will not be subjected to the same extensive scrutiny as larger institutions. While providing this reassurance, however, the statement goes on to remind the smaller banks that they are nevertheless subject to a variety of risk management requirements, running the gamut from commercial loan risk management, commercial loan administration, commercial lending regulations and interest rate risk to funding and liquidity management.

Dodd-Frank established a variety of new or enhanced regulatory powers, even creating an entirely new agency to regulate consumer financial products and services. Much of the actual lawmaking, however, was left to federal regulatory bodies. In many instances, those agencies’ regulations remain works in progress more than two years after Dodd-Frank became law. The coming months and years will reveal the extent to which the lessons learned from stress tests of “megabanks” are relevant to smaller institutions.     

The regulatory environment for commercial lenders has grown more complex and more difficult to manage.  This is particularly true for regional and local banks where the requirements for regulatory activities are as great as for major international financial institutions and there are fewer resources available to address the problems that can arise.  Commercial loan portfolio risk management, commercial lending and commercial lending regulations are topics that are required for every bank that is involved in commercial lending. 

What kind of issues can arise for the commercial lender?  There are many regulations that every commercial lender must take into consideration.  Here are some of the issues that you must consider:

CRA – Community Reinvestment Act

Small businesses are a key and growing element in CRA compliance requirements.  Economic development in selected communities require significant data capture but represent a real opportunity to expand business opportunities for the bank.

ADA – Americans with Disabilities Act

Any commercial lending that involves commercial buildings must take into account the provisions of the ADA.  No banker can be involved with a financial transaction that does not fully accommodate the ADA’s requirements.

ECOA – Equal Credit Opportunity Act

In today’s credit markets, ECOA is applicable to many small business loans and the commercial lender needs to ensure that all requirements are met.

Fair Housing

Fair housing is a long standing requirement going back to the Civil Rights Act of 1866.  While not a new requirement, commercial loans can fall under the requirement of these provisions.

What is a commercial banker to do?   Bankers engaged in commercial lending, and especially commercial real estate lending, need to be sure that they are adequately educated about the multitude of non-commercial lending regulations that may apply to their loans or to their borrowers.

Save all the contacts associated with a loan.

Save their business and personal financial statemements as well as business and personal tax returns. Ticklers will remind you when information is due. Letters and emails can be generated to request information. …

The Madison System provides a wide range of risk management reports and analytics. It is a comprehensive risk management solution for your portfolio.

• Stress test reports let you identify the weakest loans.
• Loan Rating Migration reports show how loan ratings are changing over time.
• Portfolio stratification and concentration reports provide important profiles of your portfolio.
• Delinquency data can ge grouped and sorted by dozens of variables.
• Madison Reports allow you to slice and dice the portfolio with ease so you can see and report on the

  information that is important to your situation.

• With the click of a mouse button you can select the weakest loans in your portfolio based on rating, LTV, DSCR, or Delinquency status.
• You can keep on top of loans that merit special attention with the Watch List report.
• View all FASB 114 loans instantly.