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By: Prince Varma Part 2 Two additional tactics that you should incorporate into your relationship management penetration strategy include: Conducting relationship reviews in addition to loan reviews; and Identifying and proactively monitoring changes in client behavior. Relationship reviews Relationship reviews are a comprehensive and thorough examination of the client’s business and should be the foundation for your relationship management process. They seek to provide both the client and the relationship manager with a roadmap for the upcoming 14- to 16-month period by identifying specific goals and concerns, as well as constructing a snapshot of the client today. The purpose of a relationship review is to understand the broader direction.  Bluntly put, an annual loan review is not a penetration activity. Its primary focus is to verify the ongoing credit worthiness of an existing deal in the books. More details will come about this topic in a future blog. Monitoring changes in behavior Monitoring changes in client behavior through the use of “activity thresholding” is quickly becoming a mainstay in the financial industry. The idea isn’t new; however, the application of the concept to penetration is. Instead of having changes in credit score trigger an alert related to risk management and mitigation, we would instead look at thresholds related to line usage, number of deposit transactions, changes in average deposit amount and credit card transactions. These kinds of client behaviors and activities provide insight into what is occurring within a clients business and as such, allow us to provide recommendations for products and services that are meaningful and appropriate.

This post is a feature from my colleague and guest blogger, Barry Timm, Senior Process Architect in Advisory Services at Baker Hill, a part of Experian. 2008 has proven to be an unbelievably challenging year for the economy as a whole, let alone the financial industry.  Never before have we experienced the type and degree of turmoil that we did in 2008, even since the “Great Depression”. These economic challenges have been quick, severe and widespread; and, from large corporations to the individual consumer, all have been impacted to some degree.  The stock market is down, unemployment up, consumer confidence down, delinquencies up ….not exactly a pleasant roller coaster ride. And, there is no longer any projecting as to when the “bubble” is going to burst.  It happened.   Decreased real estate values have occurred not only in high impact geographic regions but throughout the country.  While home equity products have traditionally been the “golden child” of consumer loan product offerings, recent economic changes have caused a shift in that perspective.  As a result, tightened underwriting standards have limited the availability of the product as a whole.  In some markets the product offering has even been temporarily halted. We frequently hear the terminology “bailout” being used in the news.  While we all have expectations as it relates to the bailout approach, I thought I would “Google” the word “bailout” to see what would magically appear.  Interestingly enough, the first listing was titled “Walk away from your home”, with a link to the home page for a mortgage default legal team.  This is not exactly what I was expecting to find, but is definitely reflective of the times. And, according to the FDIC, there have been 25 failed financial instituions in the year 2008.  This single year number equates to the total number of failed financial institutions between the prior periods 2001 through 2007. Okay … enough doom and gloom.  In spite of all that has occurred within the economy, some financial institutions continue to maintain a strong credit quality position in their consumer portfolios and have maintained profitability throughout all of the market volatility. What are the strong survivors doing that differentiates themselves from the others? 1. They understand their portfolio.   Advisory Services frequently assists clients with various types of portfolio management analysis and often presents those findings to senior management.  We often hear that management is surprised by the results of that analysis. The point is that high-level management reporting is not enough these days. Additional detail and depth are necessary. More specifically, as opposed to evaluating payment performance at the portfolio level, it is important to consider the following: Do you know your delinquency numbers at the product level? How do delinquencies compare to your product approval rates? Do you routinely compare approval/decline rates and delinquencies to scorecard results and/or credit bureau scores? Do you know where pricing exceptions are being made and are you receiving sufficient return for the level of risk? 2. A focused strategy is in place. It is important to re-emphasize the specific, strategic direction and focus of your defined market.  Now is not the time to be “pushing the envelope” and extending into untested waters.  There is something to be said about focusing on your strengths, staying within your defined footprint and meeting the needs of your core, proven line of business while following sound financial risk management. 3. The underwriting process is under control. This does not automatically mean that a “tightening” of underwriting standards is necessary.  It does mean, however, that stronger attention to detail is warranted.  It is important that underwriting criteria is reviewed and that you are sure that defined underwriting practices are consistently applied.  As noted in item number one above, this may require digging a little deeper and reviewing current and past decisioned loans (preferably with a critical eye of an independent third party).  Assessing the underwriting process becomes increasing complex and more critical with a decentralized underwriting approach. Focus on the positive Now that 2008 is behind us, let’s continue to focus on the positives to come in 2009.  Reflect on the past, but strive to center your attention on ongoing portfolio monitoring, financial risk management assessments and improvements for the future.  

If you have detected a Red Flag in connection with a credit application, are you prohibited from opening the account when following the Red Flag guidelines?First, you must assess whether the Red Flag evidences a risk of identity theft and your response must be commensurate with the degree of risk that is posed. You generally are not prohibited from opening the account, unless the only appropriate response in light of the degree of risk posed by the Red Flag would be not to open the account. In some instances, for example, you may be able to contact the applicant directly to verify that the application is legitimate. 

Part fourImproved change management process is one of the items at the very top of many collections professional’s wish list. In most legacy collections systems, the change management process is slow, expensive and labor intensive. It is not uncommon for an organization to take three, six or even 12 months to implement a system change, depending on the complexity of the request. Additionally, the expenses for a vendor or internal IT department to code, test and deploy the change can cost tens or hundreds of thousands of dollars. Aside from the cost and timelines, the impact to the business can be suffocating, particularly when the business users are unable to keep up with rapidly changing requirements.Change controlOne of the most exciting and innovative features of next generation collection management software systems is the ability to make changes quickly and efficiently, without the need for hard coding or extensive testing. Additionally, change control responsibilities can be granted to business users, who can then be empowered to make system changes, without the support of the software vendors or their internal IT departments. If desired, the change controls can be segmented or shared to ensure (via secure access rights) that only qualified individuals are empowered to make changes and that their skill and knowledge align with the assigned access. Regardless of where the control lies, the entire organization benefits from a change management process that is fast, efficient and easy to manage.The types of system changes that benefit from modern technology include just about any imaginable task. Simple screen or scripting changes fall on one side of the complexity spectrum, while modifications to database layouts lean towards the other end. Linking to other complimentary systems and data sources is also quicker and easier which enables hooks to be implemented in days and weeks rather than months or years.Financial benefitThe financial benefit metric of improved change management is relatively straight forward, although it is not always possible to accurately gauge the benefit ahead of the change event itself. For example, the financial value can be calculated as the benefit of the change itself (considering only the time it is in production) ahead of when it would have been deployed in a legacy environment. Additionally, we must factor the labor and fees that would have been spent to implement the change in the legacy system, less what was actually spent. For example, let’s assume a given change adds $50,000 in monthly benefits. Let’s also assume that we can implement and test the change in a next generation system in one week, while the same change could take six months in a legacy system. The value of the faster change is then $300,000 and we have saved a significant amount of money in labor and fees above and beyond that. One of the key benefits of next generation systems is that these collections efficiency changes can be made in days or weeks rather than months or years. Considering that in a year an organization with modern technology could design and implement many beneficial changes rather than just a handful, the return on investment increases exponentially with additional change management activity.My next blog will be the last in this “next generation collections systems” series and brings together the financial benefits highlighted in my previous blogs in the form of an ROI case study. Common objections and relevant considerations will also be discussed.Stay tuned! 

By: Prince Varma Hello. My name is Prince Varma and I’ve spent the better part of the last 16 years helping financial institutions (FI) successfully improve their in business development, portfolio growth and client relationship management practices. So, since the focus of this blog is to speak to readers about risk management, many of you are probably wondering what a “sales and business development” guy is doing writing a piece related to mitigating and managing risk? Great question! The simple fact is that the traditional or prevailing sentiment or definition related to risk management – mitigating credit risk -- is incomplete. A more accurate and comprehensive approach would be to recognize, acknowledge and address that “risk” cuts across the entire client relationship spectrum of: client penetration/growth; client retention; and client credit risk mitigation. How do penetration and retention count as “risk factors”? (this is where the sales guy stuff comes in) From a penetration perspective, the failure to recognize potential opportunities either within the existing client base or in the operating market, introduces revenue growth risk (meaning we aren’t keeping our eye on the top line). Ultimately it impacts the FI’s ability to add assets (either deposits or loans) and also has a direct affect on efficiency and deposit to loan ratios. From a retention perspective, the risk is even more obvious. Our most valued clients are the ones that we must continuously engage in a proactive manner. Let’s face it. In even the smallest markets, there are no less than four to six other institutions waiting to jump on your client in the event that you grow complacent. There is a huge difference between selection and satisfaction. And, if we aren’t focused on keeping a client after securing them, our net portfolio growth targets will be impossible to achieve. Considering the current market environment, now more than ever, effectively managing these three elements of “risk/exposure to the FI” is crucial to an institutions success both practically and pragmatically. Everyone internally at the bank is focused on the “credit risk mitigation” piece. The conversations that are occurring outside of the bank’s walls however are focused on the “L” word or liquidity and getting credit flowing again. How many times have we read or more frankly been beaten with this comment from business owners “…there’s no one making loans anymore…” or “…its impossible to get credit…?” That should be read as … penetration and retention Striking a balance between effective and appropriate credit risk exposure and deepening or growing the portfolio has been a challenge facing those of us in the front office for as long as I can remember. The “sales revolution” is effectively over. We’ve learned the critical lesson that we need to evolve beyond being strictly a credit officer (you did learn that right??!!). And, you didn’t/shouldn’t become a “banking products generalist” with no analytical depth. Knowing all this, it is important that we return to the guiding principles of effective lending which include: - evaluating the scope of the opportunity; - isolating the risk and identifying a reasonable and realistic recovery/mitigation remedy; - determining what other alternatives the borrower might be considering; and - being willing to let the “bad deals” walk. In subsequent blogs, I’ll provide you with specific tactics aimed at optimizing penetration and retention efforts and implementing effective and practical client management strategies. After all what would you expect from a business development guy…

When you begin thinking about financial risk management, you must begin with a vision for your loan portfolio and the similarity of a loan portfolio to that of an investment portfolio.  Now that you have that vision in place, we can focus on the overall strategy to achieve that vision. A valuable first step in loan portfolio monitoring is to establish a targeted value by a certain time (say, our targeted retirement age).  Similarly, it’s important that we establish our vision for the loan portfolio regarding overall diversification, return and the management of risk levels. The next step is to create a strategy to achieve the targeted state.  By focusing on the gaps between our current state and the vision state we have created, we can develop an action plan for achieving the future/vision state.  I am going to introduce some rather unique ideas here. Consider which of your portfolio segments are overweight?  One that comes to mind would be the commercial real estate portfolio.  The binge that has taken place over the past five plus years has resulted in an unhealthy concentration of loans in the commercial real estate segment.  In this one area alone, we will face the greatest challenge of right-sizing our portfolio mix and achieving the appropriate risk model per our vision. We have to assess our overall credit risk in the portfolios next.  For small business and consumer portfolios, this is relatively easy using the various credit scores that are available to assess the current risk.  For the larger commercial and industrial portfolios and the commercial real estate portfolios, we must employ some more manual processes to assess risk.  Unfortunately, we have to perform appropriate risk assessments (current up-to-date risk assessments) in order to move on to the next stage of this overall process (which is to execute on the strategy). Once we have the dollar amounts of either growth or divestiture in various portfolio segments, we can employ the risk assessment to determine the appropriate execution of either growth or divestiture.

By: Tom Hannagan   Part 5 This continues the updated review of results from the Uniform Bank Performance Reports (UBPR), courtesy of the FDIC, for 2008. The UBPR is based on the quarterly required Call Reports submitted by insured banks. The FDIC compiles peer averages for various bank size groupings. Here are some findings for the two largest groups, covering 494 reporting banks. I wanted to see how the various profit performance components compare to the costs of credit risk discussed in my previous post. It is even more apparent than it was in early 2008 that banks still have a ways to go to be fully pricing loans for both expected and unexpected risk. Peer Group 2 (PG2) consists of 305 reporting banks between $1 billion and $3 billion in assets. PG2’s Net Interest Income was 5.75 percent of average total assets for the year. This is also down, as expected, from 6.73 percent in 2007. Net Interest Expense also decreased from 3.07 percent in 2007 to 2.31 percent for 2008.  Net Interest Margin, also declined from 3.66 percent in 2007 to 3.42 percent in 2008, or a loss of 24 basis points. These margins are 31 bps or 10 percent higher than found in Peer Group 1 (PG1), but the drop of .24 percent was much larger than the .05 percent decline in PG1. As with all banks, Net Interest Margins have shown a steady chronic decline, but the drops for PG2 have been coming in larger chunks the last two years -- -24 basis points last year after dropping 16 points from 2006 to 2007. Behind the drop in margins, we find loans yields of 6.53 percent for 2008, which is down from 7.82 percent in 2007. This is a decline of 129 basis points or 16 percent. Meanwhile, rates paid on interest-earning deposits dropped from 3.70 percent in 2007 to 2.75 percent in 2008. This 95 basis point decline represents a 26 percent lower cost of interest-bearing deposits. Again, with a steeper decline in interest costs, you would think that margins should have improved somewhat. It wasn’t meant to be. We see the same two culprits as we did in PG1. Total deposit balances declined from 78 percent of average assets to 77 percent which means again, that a larger amount had to be borrowed to fund assets. Secondly, non-interest bearing demand deposits continued an already steady decline from 5.58 percent of average assets in 2007 to 5.03 percent. This, of course, resulted in fewer deposit balances relative to total asset size and a lower proportion of interest-cost-free deposits. Check my next blog for more on an analysis of Peer Group 2’s fee income, operating expenses and their use of risk-based pricing.  

By: Tom Hannagan Part 4 Let’s dig a bit deeper into why Peer Group 1’s margins didn’t improve. We see two possible reasons: Total deposit balances declined from 72 percent of average assets to 70 percent. This means that a larger amount had to be borrowed to fund their assets. Secondly, non-interest bearing demand deposits declined from 4.85 percent of average assets to 4.24 percent. So, fewer deposit balances relative to total asset size, along with a lower proportion of interest-cost-free deposits, appear to have made the difference. Fee income Non-interest income, again as a percent of average total assets, was down to 1.12 percent from 1.23 percent in 2007. This was a decline of 9 percent. For Peer Group 1 (PG1), fees have also been steadily declining relative to asset size, down from 1.49 percent of assets in 2005. A lot of fee income is deposit based and largely based on non-interest bearing deposits. So, the declining interest-free balances, as a percent of total assets, are a source of pressure on fee income and have a negative impact on net interest margins. Operating expenses Operating expenses constituted more bad news as they increased from 2.63 percent to 2.77 percent of average assets. Most of the large scale cost-cutting didn’t get started early enough to favorably impact this number for last year. Historically, this metric has moved down, irregularly, as the size of the largest banks has grown. This number stood at 2.54 percent in 2006, for instance. We saw increase in both 2007 and again in 2008. As a result of the decline in margins and the larger percentage decline in fee income, while operating costs increased, the Peer Group 1 efficiency ratio lost ground from 57.71 percent in 2007 up to 63.70 percent in 2008. This 10 percent increase is a move to the bad. It means every dollar in gross revenue [net interest income + fee income] cost them almost 64 cents in administrative expenses in 2008. This metric averaged 55 cents in 2005/2006. The total impact of changes in margin performance, fee income, operating expenses and the 2008 increase in provision expense of 87 basis points, we arrive at a total decline in pre-tax operating income of 1.23 percent on total assets. That is a total decline of 80 percent from the pre-tax performance in 2007 of 1.53 percent pre-tax ROA to the 2008 result for the group of only .30 percent pre-tax ROA. It would appear that banks have not been utilizing pricing enough credit risk into their loan rates.  This would be further confirmed if you compared bank loan rates to the historic risk spreads and absolute rates that the market currently has priced into both investment grade and below-investment-grade corporate bonds. These spreads have decreased some very recently, but it is predicted that more credit risk is present than bank lending rates would indicate.

Back during World War I, the concept of “triage” was first introduced to the battlefield.  Faced with massive casualties and limited medical resources, a system was developed to identify and select those who most needed treatment and who would best respond to treatment.  Some casualties were tagged as terminal and received no aid; others with minimal injuries were also passed over.  Instead, medical staff focused their attentions on those who required their services in order to be saved.  These were the ones who needed and would respond to appropriate treatment. Our clients realize that the collections battlefield of today requires a similar approach.  They have limited resources to face this mounting wave of delinquencies and charge offs.  They also realize that they can’t throw bodies at this problem. They need to work smarter and use data and decisioning more effectively to help them survive this battle.Some accounts will never “cure” no matter what you do.  Others will self-cure with minimal or no active effort. Taking the right actions on the right accounts, with the right resources, at the right time is best accomplished with advanced segmentation that employs behavioral scoring, bureau-based scores and other relevant account data. The actual data and scores that should be used depend on the situation and account status, and there is no one-size-fits-all approach.Future related articles will dive deeper into the various segmentation approach options and explain how advanced decisioning provides additional benefit over the score-only methods. 

By: Tom Hannagan Part 3 I believe it is quite important to compare your bank or your investment plans in a financial institution to the results of peer group averages. Not all banks are the same, believe it or not. In this column, we use the averages. Again, look for the differences in your target institution. About half of them beat certain performance numbers, while the other half are naturally worse. It can tell a useful story. This continues the updated review of results from the Uniform Bank Performance Reports (UBPR), courtesy of the FDIC, for 2008. The UBPR is based on the quarterly required Call Reports submitted by insured banks. The FDIC compiles peer averages for various bank size groupings. Here are the findings for the two largest groups that cover 494 reporting banks. I wanted to see how the various profit performance components compare to the costs of credit risk discussed in my previous post. It is even more apparent than it was in early 2008 that banks still have a ways to go to be fully pricing loans for both expected and unexpected risk. Peer Group 1 (PG1) is made up of the largest 189 reporting banks or those with over $3 billion in average total assets for 2008. Interest income was 5.25 percent of average total assets for the period. This is down, as we might expect, based on last year’s decline in the general level of interest rates from 6.16 percent in 2007. Net Interest Expense was also down from 2.98 percent in 2007 to 2.06 percent average for the year. Net Interest Margin, the difference between the two metrics, was down from 3.16 percent in 2007 to 3.11 percent as a percentage of total assets. It should be noted that Net Interest Margins have been in a steady, chronic decline for at least 10 years, with a torturous regular drop of 2 to 5 basis points per annum in recent years. Last year’s drop of five basis points is in line with that progression and it does add to continuing difficulty in generating bottom-line profits. To find out a bit more about why margins dropped, especially in light of the steady increase in lending over the same past decade, we looked first at loan pricing yields. For PG1 these averaged 6.12 percent for 2008, down (again, expectedly) from 7.32 percent in 2007. This is a drop of 120 basis points or a decline of 16 percent. Meanwhile, rates paid on interest-earning deposits dropped from 3.41 percent in 2007 to 2.39 percent in 2008. This 102 basis point decline represents a 30 percent lower interest expense on interest-bearing deposits. Based only on these two metrics, it seems like margins should have improved and not declined for these banks. Check my next blog for more on the reasons for Peer Group 1’s drop in margins and an analysis of the fee income and operating expenses for these institutions.

Part twoImproved collector productivity and cash flow is the concept of doing more work with existing staff or doing the same amount of work with fewer human resources. In its most simplistic form, the associated metric is the number of cases worked per employee in a given amount of time. While the definition of cases worked can be open to interpretation, the most common qualifier is that an action from a pre-defined list must be executed and documented for each account.When leveraging modern technology to achieve these results, the first objective is to channel the accounts that benefit the most from human intervention. Real-time segmentation that considers the most current status of the case is a key feature in new systems that ensure accounts are placed in the right place at the right time. This makes certain that accounts find their way to the most appropriate skill level so that less experienced staff are not overwhelmed and more experienced staff are not tasked with easier activities that distract them from solving more complex situations.  Context-sensitive screens and menus can further improve the productivity gains when collectors are working accounts. When collectors have the data they need to perform a task or make a decision without having to sift through irrelevant information, handling time is significantly reduced.  Refreshing the screens and menus in real time as an account status changes is another key feature in today’s technology that ensures the appropriate information is always presented to the collector.Real-time scriptingReal-time scripting that is capable of being updated along with the changing situation is another productivity contributor, as is user-friendly screens. Not only is handling time further reduced, but gains can be found in significantly shorter training time for new staff members. Enabling the business users to change screen content, scripting, menus and visual aids on the fly is a powerful benefit of next generation collections systems. The ability to support champion / challenger testing for any visual or screen content changes further enables the organization to test and validate work stream improvements. In addition to the benefits mentioned above, advanced scripting and on-line help can significantly assist an organization to adhere to legal and compliance requirements.Real-time segmentationReal-time segmentation, coupled with context sensitive screens that refresh as the account situation changes (even in the midst of a negotiation) facilitate more effective negotiations. This lets collectors send more appropriate and relevant messaging to customers.  Further improvements can be attributed to enabling a holistic view of the customer relationship and the relevance and effectiveness will be more consistent across the organization. The net effect is collecting more dollars per negotiation from the same population of customers that will be contacted in a faster manner.Real-time segmentation of accounts also provides the added benefit of keeping accounts in an active status and as a result makes your collections work stream more efficient. Not being dependent upon a batch process to update and route accounts ensures that each case is always in the right place at the right time and never in a holding pattern awaiting a transfer between work queues or departments. As a result, the organization will see more efficient case handling and a faster collection of debt.Improved productivity and real-time dashboardingImproved productivity reporting and real-time dashboarding enable line managers to provide appropriate feedback to collectors to make certain that Key Performance Indicators (KPI) goals are met on a regular basis. The resources in need of coaching or training can be identified before the substandard performance significantly reduces team objectives and collectors that excel can be provided with timely and accurate positive reinforcement.Gains in productivityWhen migrating to modern technology, it is very common that organizations experience at least a 20 percent gain in productivity improvement initially. This equates to the possibility of 20 fewer headcount in a team of 100 to handle the same workload. Alternatively, the existing team could handle 20 percent more accounts with approximately the same average results per account. Assuming a fully loaded cost of $50,000 a year per headcount, a 20 percent productivity boost in this example would roughly translate to a million dollars annually in financial benefit. When considering the additional benefit of reduced cost of training, this number will be even higher.Thanks for coming back. My next two blogs will provide additional details on the benefits of next generation collections systems including reduced operational and overhead costs and improved change management process.Stay tuned! 

Part oneIn today’s collections environment, the challenges of meeting an organization’s financial objectives are more difficult than ever.  Case volumes are higher, accounts are more difficult to collect and changing customer behaviors are rendering existing business models less effective.When responding to recent events, it is not uncommon for organizations to take what may seem to be the easiest path to success — simply hiring more staff. Perhaps in the short-term there may appear to be cash flow improvements, but in most cases this is not the most effective way to cope with long-term business needs. As incremental staff is added to compensate for additional workloads, there is a point of diminishing return on investment and that point can be difficult to define until after the expenditures have been made. Additionally, there are almost always significant operational improvements that can be realized by introducing new technology and the relevant ROI models often forecast very accurately.So, where should a collections department consider investing to improve financial results? The best option will probably not be the obvious choice and the mere thought can make the most seasoned collections professionals shudder … replace the core collections system with modern technology.That said, let’s consider what has changed in recent years and explore why the replacement proposition is not nearly as difficult or costly as it once was. In addition, I’ll discuss how the value proposition typically makes this option extremely appealing today.The collections system software industry is on the brink of a technology evolution to modern, next-generation offerings. Legacy systems are typically inflexible and do not allow for an effective change management program. This handicap leaves collections departments unable to keep up with rapidly changing business objectives that are a critical requirement in surviving through these tough economic times. Today’s collections managers face the need to reduce operational costs while improving other objectives such as reducing losses, improving cash flow and promoting customer satisfaction (particularly with customers that pose a greater lifetime profit opportunity).  The next generation collections software squarely addresses these business problems and provides significant improvement over legacy systems. Not only is this modern technology now available, but, the return on investment models are extremely compelling and have been proven in markets where successful implementations have already occurred.This blog is the first of a four part series. I will continue to explain, in detail, the benefits of next generation collections systems while specifically focusing on improved productivity and cash flow; reduced operational and overhead costs; and improved change management processes.Please check back soon! 

Recently we conducted an informal survey, the results of which indicate that loan portfolio growth is still a major target for 2009.  But, when asked what specific areas in the loan portfolio -- or how loan pricing and profitability -- will drive that growth, there was little in the way of specifics available.  This lack of direction (better put, vision) is a big problem in credit risk management today. We have to remember that our loan portfolio is the biggest investment vehicle that we have as a financial institution.  Yes; it is an investment. We choose not to invest in treasuries or fed funds -- and to invest in loan balances instead -- because loan balances provide a better return.  We have to appropriately assess the risk in each individual credit relationship; but, when it comes down to the basics, when we choose to make a loan, it is our way of investing our depositors’ money and our capital in order to make a profit. When you compare lending practices of the past to that of well-tested investment techniques, we can see that we have done a poor job with our investment management.  Remember the basics of investing, namely: diversification; management of risk; and review of performance.  Your loan portfolio should be managed using these same basics.  Your loan officers are pitching various investments based on your overall investment goals (credit policy, pricing structure, etc.).  Your approval authority is the final review of these investment options.  Ongoing monitoring is management of the ongoing risk involved with the loan itself. What is your vision for your portfolio?  What type of diversification model do you have?  What type of return is required to appropriately cover risk?  Once you have determined your overall vision for the portfolio, you can begin to refine your lending strategy.

By: Tom Hannagan Part 2 In my last post, I started my review of the Uniform Bank Performance Reports for the two largest financial institution peer groups through the end of 2008. Now, lets look at the resutls relating to credit cost, loss allowance accounts and the impacts on earnings. Again, as you look at these results, I encourage you to consider the processes that your bank currently utilizes for credit risk modeling and financial risk management. Credit costs More loans, especially in an economic downturn, mean more credit risk. Credit costs were up tremendously. The Peer group 1 banks reported net loan losses of .89% of total loans. This is an increase from .28% in 2007, which was up from an average of 18 basis points on the portfolio in 2006/2005.  The Peer group 2 banks reported net loan losses of .74%. This is also up substantially from 24 basis points in 2007 and an average of 15 basis points in 2006/2005. The net loan losses reported in the fourth quarter significantly boosted both groups’ year-end loss percentages above where they stood through the first three quarters last year. Loss allowance accounts Both groups also ramped up their reserve for future expected losses substantially. The year-end loss allowance account (ALLL) as a percent of total loans stood at 1.81% for the largest banks. This is an increase of almost 50% from an average of 1.21% in the years 2007/2004. Peer group 2 banks saw their reserve for losses go up to 1.57% from an average of 1.24% in the years 2007/2004. The combination of covering the increased net loan losses and also increasing the loss reserve balance required a huge provision expenses. So, loan balances were up even in the face of increased write-offs and expected forward losses. Impacts on earnings Obviously, we would expect this provisioning burden to negatively impact earnings. It did, greatly. Peer group 1 banks saw a decline in return on assets to a negative .07%. This is just below break-even as a group. The average net income percentage stood at .42% of average assets at the end of the third quarter. So, the washout in the fourth quarter reports took the group average to a net loss position for the year. The ROA was at .96% in 2007 and an average of 1.26% in 2006/2005. That is a 111% decline in ROA from 2007. Return on equity also went into the red, down from 11.97% in 2007. ROE stood at 14.36% in 2005. For the $1B to $3B banks, ROA stood at .35%. This is still a positive number, however, it is way down from 1.08% in 2007, 1.30% in 2006 and 1.33% in 2005. The decline in 2008 was 67% from 2007. ROE for the group was also down, at 4.11% from 12.37% in 2007. The drops in profitability were not entirely the result of credit losses, but this was by far the largest impact from 2007. The seriously beefed-up ALLL accounts would seem to indicate that, as a group, the banks expect further loan losses, at least through 2009.  These numbers largely pre-dated the launch of the Troubled Asset Relief Program and the tier one funding it provided in 2008. But, it is clear that banks had not contracted lending for all of 2008, even in the face of mounting credit issues and a declining economic picture. It will be interesting to see how things unfold in the next several quarters.

By: Tom Hannagan Part 1 It may be quite useful to compare your financial institution's portfolio risk management process or your investment plans , to the results of peer group averages. Not all banks are the same -- believe it or not. Here are the averages. You should look for differences in your target institution. About half of them beat certain performance numbers and the other half may be naturally worse. As promised, I have again reviewed the Uniform Bank Performance Reports for the two largest peer groups through the end 2008. The Uniform Bank Performance Report (UBPR) is a compilation of the FDIC, based on the call reports submitted by insured banks. The FDIC reports peer averages for various bank size groupings and here are a few notable findings for the two largest groups that covers 494 reporting banks. Peer group 1 Peer group 1 consisted of 189 institutions over $3 billion in average total assets for the year. Net loans accounted for 67.31% of average total assets, which is up from 65.79 % in 2007. Loans, as a percent of assets, have increased steadily since at least 2004. The loan-to-deposit ratio for the largest banks was also up to 96% from 91% in 2007 and 88% in both 2006 and 2005. So, it appears these banks were lending more in 2008 as an allocation of their total asset base and relative to their deposit sources of funding. In fact, net loans grew at a rate of 9.34% for this group, which is down from the average growth rate of 15.07% for the years 2005 through 2007.  The growth rate in loans is down, which is probably due to tightened credit standards. However, it is still growth. And, since total average assets also had growth of 11.58% in 2008, the absolute dollars of loan balances increased at the largest banks. Peer group 2 Peer group 2 consisted of 305 reporting financial institutions between $1B and $3B in total assets. The net loans accounted for 72.96% of average total assets, up from 71.75% in 2007. Again, the loans as a percent of total assets have increased steadily since at least 2004. The loan-to-deposit ratio for these banks was up to 95% from 92% in 2007 and an average of 90% for 2006 and 2005. So, these banks are also lending more in 2008 as a portion of their asset base and relative to their deposit source of funding. Net loans grew at a rate of 10.48% for this group in 2008 which is down from 11.94% growth in 2007 and down from an average growth of 15.04% for 2006 and 2005. And, since total average assets also had growth of 10.02% in 2008, the absolute dollars of loan balances also increased at the intermediate size banks. Again here, the growth rate in loans is down, probably due to tightened credit standards, but it is still growth and it is at a slightly more aggressive rate than the largest bank group. Combined, for these 494 largest financial institutions, loans were still growing through 2008 both as a percentage of asset allocation and in absolute dollars. Tune in to my next blog to read more about the results shown relating to credit costs, loss allowance accounts and the impacts on earnings.