The economic fallout from the COVID pandemic is causing a worrying increase in the business lending risk of credit unions. To meet this challenge, the NCUA and its sister agencies have published new Interagency guidelines in June 2020 to strengthen their expectations of how financial institutions should monitor credit risk within their portfolios.
The guide provides a wide range of practices that can be used to form a credit risk review system compatible with safe and sound lending practices. While these guidelines are designed for all types of loans, they are particularly relevant for commercial loan operations.
The Small Business Administration has also released new guidelines for underwriting 7 (a) loans during the COVID-19 pandemic, also providing a strong structure for managing risk in non-SBA loans.
In accordance with these federal guidelines and industry best practices, CU Business Group recommends that lenders focus on five key areas to ensure your credit union stays ahead in these turbulent and uncertain times.
1. Integrate credit risk management into your policies and procedures.
The NCUA and state regulators have taken a closer look at lending policies in recent reviews. The good news is that in hundreds of credit union business portfolio reviews conducted over the past few years, CUBG has found that, overall, credit union business lending policies and procedures are now more robust, detailed and adapted to the level of risk present in the portfolio.
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According to Interagency Guidance, “An effective credit risk review system begins with a written credit risk review policy that is reviewed and generally approved at least once a year by the board of directors of the institution or appropriate board committee to demonstrate support and commitment to, maintaining an effective system.
Make sure that your credit risk review policy addresses the following areas, according to the guidelines:
- Qualifications of staff responsible for credit risk review;
- Independence of staff;
- Frequency of examinations;
- Scope of the review;
- Thorough review of the transaction or portfolio;
- Review of findings and follow-up; and
- Communication and dissemination of results.
In addition, it is important that your maximum loan limits and thresholds are listed correctly and consistently in your policy and procedures, and are updated accordingly when changes are made.
2. Establish a credit risk rating system.
Under the guidelines, your independent credit risk review team is responsible for creating a credit risk scoring (or scoring) framework.
This framework should include a formal description of the components of each rating score and be documented in your policy. Lending staff are responsible for assigning accurate and timely risk ratings and identifying emerging issues.
The framework should ensure that problematic loans are identified and included in a watchlist, that approved recovery plans are evaluated to assess their effectiveness, and that the loss history for each segment of the portfolio is identified. Also, don’t forget to document your Distressed Debt Training and Restructuring (TDR) processes in your policy and procedures.
Finally, it is a good practice to review and update your risk scoring system every few years to ensure that it remains up to date with the latest risks, industry concentrations and conditions. local economies.
3. Tighten your underwriting and credit analysis.
Although not specifically described in the Interagency Guide, the underwriting and credit analysis step is a critical step in managing the risk of your business portfolio, especially in times of economic turmoil.
It is especially important now to collect the latest financial information and up-to-date collateral ratings from your borrowers, as business conditions that may have looked optimistic at the end of 2019 were likely to deteriorate in the first half of 2020.
The CUBG recommends using Uniform Credit Analysis (UCA) cash flow to analyze how a business uses cash in its operations, and reviewers now see this tool as a key determinant of a borrower’s ability to repay the loan.
Another important source of analysis is global debt service coverage. As business revenues have declined in some industries, the ability to weather the storm through other sources of income (such as owners and related entities) is imperative.
The ASB has published a list of additional factors lenders should take into account when analyzing new claims during the COVID pandemic, especially if the industrial sector has been severely affected by the crisis, the reliability of historical financial information and the company’s diversification with respect to its Supply Chain. CUBG also recommends creating a personalized COVID statement for each business or industry, and including it in all annual reviews and credit scores for the foreseeable future.
4. Ensure that reviews are performed annually.
Although NCUA regulations state that credit unions must perform “periodic reviews” of their member business loans, reviewers strongly suggest that these reviews be performed on an annual basis.
The purpose of these reviews is to reassess the risk of the transaction to see if it is still reasonable and appropriate for the size, type and nature of the loan.
Don’t dwell too much on the annual review schedule exactly with the anniversary of when the loan was originally booked. If possible, schedule the review approximately 90 days after the borrower files their tax returns or publishes their financial statements to make sure the most recent information is available.
Portfolio reviews should also be conducted annually, to help reveal weaknesses in lending operations or structural risks such as ongoing violations of internal policies and procedures.
The scope of your annual portfolio review is important and should cover all individual loans over a specified size representing a diverse cross section of the portfolio. The review should assess various criteria, including credit quality and underwriting, borrower performance and adequacy of sources of repayment, the creditworthiness of the guarantor, and the effectiveness of account management and strategies. credit mitigation.
Examiners pay particular attention to portfolio reviews and many lenders use an independent third-party firm for these engagements. This ensures that the review is conducted with objectivity and without conflict of interest, and helps to leverage best practices and industry expertise.
5. Report diligently.
Finally, make sure you stay on track with the NCUA board reporting requirements. According to Interagency Guidance, an effective credit management system includes a process to identify any deficiencies or weaknesses in the portfolio or individual loans, and requires effective and regular communication to the board of directors of the credit union, relevant internal committees and management of all credit risk reviews. The guidelines require credit unions to report this information to the board at least once a year, but CUBG suggests reporting more frequently, such as quarterly, given current economic volatility.
Jeff Stone is Vice President, Regulatory & Compliance for the CUSO CU Business Group based in Portland, Ore.