Loan Review Systems
Loan Review Systems
Assigned to various areas such as credit underwriting, loan administration, problem loan workout, or other areas. Responsibilities may include assigning initial credit grades, ensuring grade changes are made when needed, or compiling information necessary to assess ALLL.The complexity and scope of a loan review system will vary based upon an institution’s size, type of operations, and management practices. Systems may include components that are independent of the lending function, or may place some reliance on loan officers. Although smaller institutions are not expected to maintain separate loan review departments, it is essential that all institutions have an effective loan review system. Regardless of its complexity, an effective loan review system is generally designed to address the following objectives:
To promptly identify loans with well-defined credit weaknesses so that timely action can be taken to minimize credit loss;
• To provide essential information for determining the adequacy of the ALLL;
• To identify relevant trends affecting the collectibility of the loan portfolio and isolate potential problem areas;
• To evaluate the activities of lending personnel;
• To assess the adequacy of, and adherence to, loan policies and procedures, and to monitor compliance with relevant laws and regulations;
• To provide the board of directors and senior management with an objective assessment of the overall portfolio quality; and
• To provide management with information related to credit quality that can be used for financial and regulatory reporting purposes.
Loan Review System Elements
Management should maintain a written loan review policy that is reviewed and approved at least annually by the board of directors. Policy guidelines should include a written description of the overall credit grading process, and establish responsibilities for the various loan review functions. The policy should generally address the following items:
• Qualifications of loan review personnel;
• Independence of loan review personnel;
• Frequency of reviews;
• Scope of reviews;
• Depth of reviews;
• Review of findings and follow-up; and
• Workpaper and report distribution
Qualifications of Loan Review Personnel
Personnel involved in the loan review function should be qualified based on level of education, experience, and extent of formal training. They should be knowledgeable of both sound lending practices and their own institution’s specific lending guidelines. In addition, they should be knowledgeable of pertinent laws and regulations that affect lending activities.
Loan Review Personnel Independence
Loan officers should be responsible for ongoing credit analysis and the prompt identification of emerging problems. Because of their frequent contact with borrowers, loan officers can usually identify potential problems before they become apparent to others. However, institutions should be careful to avoid over reliance upon loan officers. Management should ensure that, when feasible, all significant loans are reviewed by individuals that are not part of, or influenced by anyone associated with, the loan approval process.
Larger institutions typically establish separate loan review departments staffed by independent credit analysts. Cost and volume considerations may not justify such a system in smaller institutions. Often, members of senior management that are independent of the credit administration process, a committee of outside directors, or an outside loan review consultant fill this role. Regardless of the method used, loan review personnel should report their findings directly to the board of directors or a board committee.
Frequency of Reviews
The loan review function should provide feedback on the effectiveness of the lending process in identifying emerging problems. Reviews of significant credits should generally be performed annually, upon renewal, or more frequently when factors indicate a potential for deteriorating credit quality. A system of periodic reviews is particularly important to the ALLL determination process.
Scope of Reviews
Reviews should cover all loans that are considered significant. In addition to loans over a predetermined size, management will normally review smaller loans that present elevated risk characteristics such as credits that are delinquent, on nonaccrual status, restructured, previously classified, or designated as Special Mention. Additionally, management may wish to periodically review insider
loans, recently renewed credits, or loans affected by common repayment factors. The percentage of the portfolio selected for review should provide reasonable assurance that all major credit risks have been identified
Depth of Reviews
Loan reviews should analyze a number of important credit factors, including:
• Credit quality;
• Sufficiency of credit and collateral documentation;
• Proper lien perfection;
• Proper loan approval;
• Adherence to loan covenants;
• Compliance with internal policies and procedures, and applicable laws and regulations; and
• The accuracy and timeliness of credit grades assigned by loan officers.
Review of Findings and Follow-up
Loan review findings should be reviewed with appropriate loan officers, department managers, and members of senior management. Any existing or planned corrective action (including estimated timeframes) should be obtained for all noted deficiencies. All deficiencies that remain unresolved should be reported to senior management and the board of directors.
Workpaper and Report Distribution
A list of the loans reviewed, including the review date, and documentation supporting assigned ratings should be prepared. A report that summarizes the results of the review should be submitted to the board at least quarterly. Findings should address adherence to internal policies and procedures, and applicable laws and regulations, so that deficiencies can be remedied in a timely manner. A written response from management with corrective action outlined, should be provided in response to any substantive criticisms or recommendations.