OFFICIAL PUBLICATION OF THE VIRGINIA ASSOCIATION OF COMMUNITY BANKS

Pub. 13 2024 Issue 3

3 Steps to Evaluate Credit Trends and Risk Management

When a message is repeated, it’s likely intended to carry some weight. In this regard, the federal banking regulators have issued more than a “friendly reminder” by placing credit risk in the top examination priorities for the year. Additional emphasis was focused on assessing how banks are identifying and responding to credit risk as economic conditions evolve. Then, in February 2024, news headlines reiterated the significance of credit risk with an update about New York Community Bank and a lacking loan review program and deteriorating credit quality trends for banks has come to the forefront.

Credit risk has been in the spotlight for years. In May 2020, federal regulatory bodies came together and issued guidance about the significance of credit risk review systems. In 2021 and 2022, financial institutions got a heavy dose of guidance on the Allowance for Credit Losses, which included key principles around credit risk identification and management. Last year, the federal regulatory agencies issued guidance on loan accommodations and workouts in anticipation of a commercial real estate meltdown. The messaging has been quite strong.

So, how is a weak loan review program a critical matter in 2024 for one of the largest financial institutions in the United States? Working with financial institutions across the nation, a common question asked is about the reassessment of credit risk appetite, culture, risk reduction strategies, concentration management and credit review functions in light of the current economic shifts and ongoing regulatory focus. However, the usual response is that not much has changed or been considered necessary as the financial institution has never received any criticism from regulators in the past.

Financial institutions have significant experience navigating evolving credit cycles, and this evolving economic and regulatory environment presents another opportunity to consider whether strategies need to change. Credit stresses are growing, and borrowers have to adjust to tighter financing conditions. Cash flow stress, lower income and higher costs are realities of an increasing number of consumer and commercial borrowers that impact their repayment performance. For your financial institution, look at the evolving credit risk exposure and consider some simple steps such as:

  1. Assess your current loan portfolio by key segments and document the risk exposure. Although commercial real estate has been making headlines, there are also signs of weakness in other consumer lending categories. Stay informed and consider the ripple effect of softening conditions throughout the entire portfolio.
  2. Evaluate your independent loan review process. Consider if your internal team is adequately staffed or providing the expertise needed. Challenge the results of third-party providers and go deeper into areas demonstrating increased risk for your financial institution. Your loan review process shouldn’t just be a validation of your assigned risk ratings. If your third‑party provider is not giving you the insights you need in the current environment, consider other options.
  3. Engage proactively with your borrowers who appear to be at risk to identify opportunities to help. The time investment today could help offset potential significant losses in the future.

Last but not least, you can also engage a trusted partner who can help you navigate the risks in your portfolio by providing a credit risk review that empowers management with insights and opportunities in your bank’s loan portfolio.

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