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Building a Strong Credit Culture

By Eric E. VanDoren, CRC, Director, Wipfli

Building and maintaining a strong credit culture at your financial institution is no easy task. But that culture will go a long way in affecting the long-term success, or lack thereof, of your organization.

The COVID-19 pandemic brought with it plenty of stresses as lenders navigated various challenges and solutions. However, banks are coming out of a period in which credit losses are at historic lows, and problem loan reports and watch lists are about as small as they ever were.

Most lending institutions ended 2022 in a strong capital position (notwithstanding unrealized losses in the securities portfolio) with minimal credit issues, regardless of the strength of the institution’s credit culture.

However, current economic uncertainties are a reminder of the need to revisit your lending approach. Your institution needs a strong credit culture to weather volatility in market conditions and the economy going forward.

Here are the key components of a strong credit culture and some changes you may need to adopt to build yours.

An Effective Loan Policy

It starts with an effective, well-defined loan policy. This is not a one-size-fits-all document. The policy should be tailored to the institution based on the local area and economy, as well as the characteristics of your institution: size, strength, expertise, types of lending offered and the borrowing needs in the local economy.

This policy document should provide for effective supervision by senior management and the board of directors. It should not be a static document and should be reviewed and approved on an ongoing basis as the circumstances of borrowers, the economy and the institution itself change. The policy also provides guidance and outlines expectations for loan officers and staff.

Careful Underwriting

Gone are the days of the handshake loans with minimal to no underwriting. Effective loan underwriting is critical in understanding the risks in a borrowing relationship. Detailed underwriting and risk analysis will help management determine whether the level of risk in each credit application is acceptable given the expected reward.

Effective loan underwriting analyzes and discusses the five Cs of credit: character, capacity, capital, collateral and conditions (and some also add control and common sense). In most instances, underwriting is performed by the credit department, providing a view independent from loan production — although in some smaller institutions this may not be possible due to limited staffing.

Credit personnel should be knowledgeable and well-trained to provide the proper analysis and uncover the risks lurking within a credit and loan request and be able to effectively articulate any concerns held by internal staff, the credit committee, board of directors or others.

A Grading Matrix

To determine and quantify the level of risk in a credit application, a clear, measurable and objective-based loan grading system should be used. A grading matrix is a great tool to assist in determining the proper loan grade and helps provide consistency in grading throughout the organization.

While a perfect grading matrix does not exist, these key objective criteria carry the most weight:

Debt service ability
Collateral coverage
Leverage
Liquidity

Other criteria — including industry, type of collateral, guarantor strength and payment history — also matter but are typically weighted less.

Once the matrix determines the score, consider whether it seems appropriate. (If it doesn’t, an adjustment to the weightings or risk factors should be considered, and an adjustment may be appropriate.

Possible reasons for an adjustment might be the sudden loss of a significant customer or the untimely death of an owner or key employee.

A grading matrix is not a one-size-fits-all tool. The expectations for a commercial real estate credit may be different than a commercial and industrial credit. Underwriting and grading an agricultural borrower would not be the same as it would for a construction or development borrower. An institution may want to consider having three or four (or even more) different grading matrices in its arsenal.

A Diligent Credit Committee

The credit committee reviews new credit requests as well as previously approved and funded loans not just for approval but also to ensure the depth and detail of the credit underwriting and analysis is commensurate with the subject request. Is the type and structure of the loan appropriate and within policy parameters as dictated by senior management and the board?

If there are exceptions to policy, are they appropriately mitigated so the level of risk in the credit is reasonable given the risk appetite of the institution? The credit committee is also frequently a learning opportunity for junior personnel to become further immersed in the credit culture of the institution.

Proper Credit Administration

Another important but often overlooked part of the credit process is loan documentation and administration. This effort includes pre-lien searches, proper titling, approved terms and conditions and accuracy of documentation. Proper checks and balances and review of loan documents are needed prior to closing. It is too easy for something to slip between the cracks due to pressure from a loan officer, borrower or attorney, as well as myriad other distractions that administrators must face.

After the loan is properly booked and funded on the system, there may be follow-up filings and post-lien searches.

Thorough Portfolio Management

Effective loan portfolio management is imperative. More than just monitoring payment performance, it involves keeping in touch with the borrower performing a site visit, if appropriate. The institution may need to obtain and review periodic financial reporting from the borrower and/or guarantors as required in the loan agreement.

Check whether the financials raise any red flags or trip any covenant requirements. If so, investigate and find out why. Do not wait until a loan becomes past due to raise concerns with the borrower.

Effective loan portfolio management goes beyond individual loan monitoring. Is the level of risk in the portfolio changing and, if so, why? Stress testing is an important tool in determining the potential risk in individual credits as well as the portfolio.

Concentration levels need to be monitored. Are the various loan types within the concentration parameters outlined in the loan policy? If not, what is the plan to return to the policy threshold? Are those threshold levels still appropriate? If exceptions are made to the policy, consider whether the level is appropriate and be sure the exceptions are being tracked and reported to senior management and the board.

Another important aspect of loan portfolio management involves the management of problem loans. Even an institution with a strong credit culture will have the occasional hiccup. The question becomes how does the lender deal with the hiccups. The earlier the loan officer can identify a potential problem, the easier it is to consider more potential solutions.

Many pieces must come together to build a strong credit culture. For management to be diligent in its oversight, having the right people in place is critical. The quickest route to financial decline for a lender is to allow complacency to take hold in any critical aspect of the lending process. While every loan is a good loan at the point of origination, a strong credit culture improves the chances it remains so.

How Wipfli Can Help

At Wipfli, we are tuned into the concerns of financial institution clients on underwriting risks. The appropriate policies help build lasting relationships and create a positive impact. Our team’s seasoned lending professionals are ready to provide guidance on best practices and help your organization achieve its goals.

Content Sponsored by Wipfli, a WBA Silver Associate Member.

March 7, 2023/by Hannah Flanders

Community, Compliance, Resources

Banks Serve Communities with Invisible Credit in an Effort to Develop Financially Capable Consumers

By Hannah Flanders

Throughout the United States, millions of Americans are left out of mainstream financial services due to their credit score, or lack thereof. As financial inclusion — with particular emphasis on providing the underbanked access, expanding opportunities for all, and eliminating barriers — becomes increasingly critical in ensuring every consumer has the possibility to gain wealth, it is equally as important that banks understand the unique challenges these individuals face and how they can best be served.

What Does it Mean to be Credit Invisible?

According to information compiled by Oliver Wyman based on data by Experian and previous Consumer Financial Protection Bureau (CFPB) research, around 28 million American adults are credit invisible. Additionally, 21 million adults in the U.S. are considered unscorable. Defined as one’s lack of credit history and score, credit invisibility often results in difficulty accessing credit products. Unscorability, on the other hand, defines the limited information one has in their mainstream credit file and therefore their lack of ability to generate a conventional credit score.

The CFPB highlights that not only are a disproportional number of credit invisible customers located in low-income neighborhoods, but that around 15% of Black and Hispanic consumers are credit invisible in comparison to only around 9% of white customers.

However, as 90% of the top lenders throughout the U.S. require at least six months of recorded credit activity, according to the credit bureau Experian, credit invisible consumers often do not have access to reliable means to establish and expand their credit.

With minimum balance requirements and fees being cited within the top five reasons as to why 4.5% of households in the U.S. remain unbanked, according to the Federal Deposit Insurance Corporation’s (FDIC) 2021 FDIC National Survey of Unbanked and Under-banked Households report, it is critical that bankers find alternative solutions for those looking to expand their opportunities, meet their financial goals, own a home, or simply begin their financial journey.

Providing Accessible Credit

Lack of access to mainstream financial services or other low-cost credit products often does not stop individuals from borrowing or seeking certain forms of financial assistance. In fact, this may inadvertently cause one to engage in high-cost, potentially predatory lending cycles.

“Banks throughout America play an important role in not only providing opportunities for consumers to access traditional credit services, but also in assisting individuals to establish and maintain their credit,” says Jeff Langkamp, vice president — chief compliance officer at Bank Five Nine in Oconomowoc. “Having no credit score most likely means that individuals will have to pay a higher interest rate or use payday lenders who charge outrageously high interest rates. Additionally, establishing a credit score to purchase a house or car allows families to build generational wealth.”

To bankers, providing access to credit may mean offering secured credit cards or developing a credit invisible loan program, which involves making smaller loans to invisibles to gradually build their scores or looking beyond the standard evaluation producers to aspects such as their residency and employment stability.

At Bank Five Nine, customers have access to the Achieve Credit Builder™ program, an account certified as meeting the Bank On National Account Standards. The product, according to Langkamp, helps individuals establish or repair their credit at little to no cost.

“The average age of our customers that are taking part in the credit builder program is 26, so the product is helping younger individuals as they begin their credit journey,” highlights Langkamp.

Positioning Consumers for Success

In December 2022, Fannie Mae announced that it would be strengthening its underwriting program Desktop Underwriter® to responsibly expand eligibility and further simplify the borrowing process for individuals without credit scores.

“Traditional lending practices make it hard for borrowers with no credit score to access credit,” said Malloy Evans, executive vice president and head of single-family business, in the press release published on December 6.“[As a result,] Fannie Mae has taken steps that may help them responsibly qualify for a home loan using data that provides a more holistic view of how they manage their money.”

The enhancements released by Fannie Mae update existing eligibility criteria to permit standard loan-to-value (LTV), combined loan-to-value (CLTV), and high credit loan-to-value (HCLTV) ratios on certain properties and expand the standard maximum allowable debt-to-income ratio to 50%. Additionally, the organization has created an automated option for documenting nontraditional credit sources to simplify the process for both the lender and the borrower.

A significant component of this update also includes allowing borrower-permissioned data that consider a borrower’s transaction patterns and balance trends.

Embracing Alternative Credit Data

As many banks and businesses across the U.S. look to alternative ways to promote financial capability among all consumers, many are looking to consumer-permissioned data. Experian defines alternative credit as expanded Fair Credit Reporting Act (FCRA)-regulated data. This data often includes rental payments, small-dollar loans, and other consumer-permissioned data.

“Each individual situation is different; the most important thing is finding a plan that fits the needs and financial goals of the individual,” emphasizes Langkamp. “In addition to resources like Achieve Credit Builder™, our bank encourages our customers to take advantage of self-reporting opportunities like rental housing, and other payments that may not be reflected on a credit report.”

As establishing good credit remains a critical component of one’s ability to acquire wealth, self-reporting has quickly become an integral aspect in assisting individuals to easily establish a credit score.

In an effort to make credit accessible to all communities, Experian has developed free resources for consumers to utilize as they develop their credit score. Experian Go™ provides individuals with education and insights unique to their credit journey. Experian Boost™ allows consumers to connect their bank account or credit card to their Experian credit file. By making on-time payments, individuals can highlight their good spending habits and raise their credit score.

“By using expanded data sources and better analytics in credit decisions, banks can help more consumers gain access to credit while making more informed decisions,” says Greg Wright, executive vice president and chief product officer for Experian Consumer Information Services. “This is a win for both lenders and consumers — and it’s just the right thing to do.”

Wright adds that score models used today have historically left nearly 50 million Americans living with a limited credit history locked out of the credit ecosystem. “Leveraging expanded data sources and advanced analytics can help change this narrative,” he emphasizes.

While credit invisible and unscorable individuals remain a significant portion of our communities, there are many opportunities for banks to assist. Whether it be offering low-cost products and secured credit cards or encouraging consumers to utilize resources that educate them on their individual credit journey, bankers play a major role in promoting financial security for generations to come.

“This is an exciting time for the banking and financial services industry,” concludes Wright. “By leveraging the right tools, we are nearing a point where we can say — no matter who you are, where you live, or what part of your financial journey you’re on — that we can score you and help you access the financial services you need.”

January 5, 2023/by Jaclyn Lindquist

Events

Compliance, Consumer / Retail, Lending

Consumer Lending Boot Camp

The 2023 WBA Consumer Lending Boot Camp will be held October 3–4 at the Wisconsin Bankers Association Office in Madison. Classes will begin at 9:00 a.m. on Tuesday and conclude at 3:00 p.m. on Wednesday.

About the Boot Camp: This program was developed to help bankers build the foundation and skills necessary to become a successful consumer lender or processor. Students will learn the process of basic lending and then put it into practice through various exercises and case studies. Consumer Lending covers the essentials of the consumer lending business today and explains the important and relevant features, processes, and laws. Students taking Consumer Lending will learn the features and benefits of consumer loan products and operations, including closed-end and open-end loans, direct and indirect lending, and secured lending. Students will gain the following from the program:

Increased knowledge of the steps and analysis process involved in consumer lending.
An understanding of the various types of consumer loans and their loan documentation requirements.
Comprehensive understanding of the various lending rules and regulations.
Improved skills in determining customer needs through the interviewing process.
The opportunity to learn from respected and experienced faculty members as well as peers.
Preparation for future study at the WBA Residential Mortgage Lending School and WBA Loan Compliance School.

Curriculum Includes:

Dynamics of Lending: understanding lending’s role in the bank and the importance of the lending decision.
Lending Compliance: including an overview of regulations geared for new lenders.
Lending Principles: a look at the 5 C’s of credit, understanding the credit report, understanding your bank’s loan policy, evaluation and quality assurance.
Consumer Lending
Types of consumer loans
Terminology
Application process and documentation
Sales/relationship building
Case study application

Who Should Attend:
This program will provide fundamental instruction appropriate for loan officer trainees, loan support personnel, new lenders, branch managers, universal bankers, and personal bankers. Attendees will receive a certificate of attendance.

Registration Information:
The registration fee of $550 includes program registration, instruction and binder and ABA materials, and all meals.

May 15, 2023/by Miranda Gustafson

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