Are you beginning to focus on managing your loan portfolio as a whole, rather than as a collection of individual loans? Do you wonder what lies just beyond the standard reports you receive as a member of the board or senior management? And what other areas ought to be measured that are not now the subject of regular reporting?
If you have some or all of these questions on your mind, it’s time to get started on portfolio-level credit management.
Going for the big picture
The goal of loan portfolio management is to set in place policies, procedures, and oversight to drive the portfolio as a whole in the desired strategic direction. If you will, the goals of loan portfolio reporting is to depict the forest—not the trees—to understand its overall proportions, characteristics, and trends.
Dwelling on the individual trees in the forest should be avoided, unless the tree is a redwood among maples and birches.
All banks use at least basic portfolio reports. There likely is not a bank in existence that does not track its loans via delinquency reporting. Similarly, loans considered criticized and classified are the subject of regular reporting as well. Balance sheet reports also show loans by general type, such as C&I, CRE, residential mortgages, and consumer loans. What is in those buckets may be opaque, except on a loan-by-loan basis where the loans show signs of weakness.
The calculation for the allowance for loan losses also exhibits characteristics of portfolio reporting. But like its cousins—delinquency and criticized/classified loan reports—it tends to focus on behaviorally weak loans and loss ratios. Even if there are different risk ratings within the portfolio, the structure of the portfolio is not revealed in the report.
Here are some of the questions you may have that instituting portfolio reporting will likely answer:
1. What kinds of loans have contributed positively to my overall loan quality? Which have been detrimental?
2. What loans may be more vulnerable as we approach the next recession?
3. Am I surprised by any concentrations I see?
4. Even qualitatively, are the segments of my portfolio highly correlated?
5. From what region/team/officer do I get my best loans? Worst?
6. What does this mean, given my business strategy?
How to build portfolio-level reporting
Portfolio reporting starts with a need for information on a loan-by-loan basis that can be captured, aggregated, and presented in a simple, useful way. You will need a basic risk rating system that goes beyond a simple pass/ no pass breakdown. For most community banks, three or four pass grades provides the right amount of granularity without getting your team lost in the weeds. If your bank does not have a reliable system in place, your first efforts should focus on instituting one.
Start where you want to go, to paraphrase an old saying. Begin with a basic list of questions you would like answered regarding your portfolio. Don’t waste resources on reports that paint pictures of the portfolio that do not address pertinent questions, and that therefore aren’t action-oriented.
Key characteristics in which you are interested typically begin with a list like this:
• Type of loan
• Loan Region/Team/Officer
• Risk rating
• Other credit info
You will need an efficient process to capture the relevant information in your loan system and create a sufficiently agile database to manipulate the data for reporting purposes. Learning to work effectively with Loan Servicing and IT represents perhaps the biggest upfront investment in assuring you have quality data for each loan.
Making the data talk to you
Once the database has been organized appropriately, you will need to design reports that answer the pertinent questions. Reports should be self-explanatory, meaning that a generally informed reader should understand the facts presented and have the capacity to begin to draw conclusions from them.
I have found that presenting information first by dollar amounts and then in a common-sized format fits the bill. By common-sized, we mean every category is presented as 100% regardless of size. The aid in analysis is great.
The use of color charts is indispensible, too. Imagine you are reporting on CRE loans by region segmented by risk rating. You will undoubtedly want to understand the total dollar value outstanding by risk rating, but also compare one region to the next. In that format, though, it is not easy to quickly identify the regions that exhibit above average quality characteristics compared to the ones that bring down the average. A simple stacked color bar chart showing the percentage breakdown from each region will make it obvious at a glance what’s happening. Many action-oriented questions may well result.
The one topic we haven’t discussed is profitability. The real goal of portfolio management is to build the desired portfolio over time, with the result that the economic value of the bank is enhanced.
Doing so requires profitability reporting. However, unless profitability measurement is fully risk adjusted, it can be misleading and lead to poor decisions. In addition, profitability measurement is often the most difficult aspect of loan portfolio management.
Much good can come from portfolio management that does not report on profitability. Understanding the components and trends in quality, industry, region and other relevant characteristics in our portfolio gets us well along in achieving the loan portfolio we want.
Time to take the first step?
In my next blog, I’ll discuss profitability measurement for loans tailored to the community banking world.