How to make sure "lending ladders" take you up, not down
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In recent weeks I've been drawn into conversations with community bankers who are reexamining their institutions' delegated credit authorities. This is a subject clearly on the minds of many these days and it probably is a good time in the business cycle to take another look at this subject. Questions such as the length of time to respond to credit requests and whether loan committees are effectively monitoring and assessing credit risk are always appropriate subjects for internal discussion.
Looking back: "What the ‘big bank thinking' was"
The first time I was actively engaged in this process was in Miami many years ago. My bank was the lead affiliate in one of the largest bank holding companies in the Southeast at the time. The question then on the table was whether our bank's credit authorities structure was appropriate for the marketplace; the bank's appetite for risk; and the training and nurturing of credit underwriting skills among the staff.
The implication was that these things, at our institution, were not grounded in current best practices or market necessity, and that it was time to update the processes for a period of active growth and more robust competition.
I was a representative of the lending practitioners in the small group who would ultimately make a recommendation to our executive management. We spent time travelling around to several banks in New York and Chicago and learned firsthand what the "big bank thinking" was at that time.
Mind you, this was during the period that many very large money-center banks had virtually abandoned the committee system for all but the very largest loans.
Climbing the lending ladder
In short, the industry consensus among the giants was that committees for most of a big bank's loan volume were not as effective as "lending ladders," in terms of both the rapid response and underwriting of credit risk.
By "lending ladder," I am referring to the degree of credit exercised by participants owning to their experience or position in the organization. It's in reality a committee-but the committee for any particular credit consists of only two people.
The key issue, our group came to realize, was how a bank trained its staff. If most everyone was trained the same way and to a reasonably high standard, then the credit skills on a particular bank's lending line were reasonable predictable as well as auditable.
But what if lenders both junior and senior had not had common lending training experiences?
That's where inconsistencies originated and were propagated. That is as true today as it was 30 years ago.
As a bank we ultimately adopted a modified lending ladder and increased the size of credits where formal committee presentations were required. At the same time we initiated a structured credit training process. It took two or three years to fully implement these changes before we could see demonstrable changes in outcomes. The consistency of our underwriting and the training of our younger lenders seemed to amply justify the time and the effort expended in implementing these changes.
How you measure lending authority efficacy
Many directorates will continue to evaluate lending authorities based primarily on turnaround time and staff competencies. But there are other important conditions and circumstances worthy of consideration as well.
One of them is how much lending authority a single loan officer should exercise in his or her own right. I have a distinct bias here based on my experience in both very large banks as well as smaller ones.
When I became CEO of the Albuquerque bank I've referred to over the course of my blogs, we had a legal lending limit in excess of $15,000,000. I recommended to the board that all officer "single" limits be reduced to $25,000 unsecured and $50,000 secured, with secured bearing the definition contained in the loan policy relating to types of collateral, margin, and supervision.
I wanted to be sure that no one, including myself, was ever put in the position of appearing to agree to a credit extension based on negotiations conducted in surroundings or circumstances too informal for the occasion-such as the 19th hole of the local country club. I've seen lenders get into trouble in such venues with unhappy consequences for customer and bank or both. I also wanted to force more credit to be scrutinized by more eyes at least until I had a much better feel for the credit culture of the bank.
Looking at loan administration structures and exceptions
Another consideration or qualifier to the appropriate level of delegated authorities is the relationship between a credit administration function where some of the analytical burden and support of credit might be housed and the relationship of Loan Review to the size of the loan portfolio.
An active and supportive credit administration can be an effective way of improving turnaround time and the quality of credit underwriting oversight. A loan review function that looks at a relatively large slice of approved commitments is also an effective check on the possible shortcomings of a lending ladder.
A key item to the maintenance of a sound credit culture is the discipline exercised toward credit exceptions.
Lending ladders can sometimes lead to a laxity in the enforcement of policy provisions. Some might refer to this as the process of "log rolling." Here's how it might work: One lender with limited individual authority might approach a participant in the lending ladder over a seemingly small credit request with the full and perhaps not unreasonable expectation that the other will simply sign off on it.
But what if your bank has a relatively loose credit and collateral exceptions strainer? How much can slip through either deliberately or accidentally?
Don't let cowboys climb the ladders unchecked
Ultimately, board delegated lending authorities are a form of internal control over the lending function of the bank. Larger banks tend to have more elaborate systems of internal control so it seems logical to me that larger banks would tend to favor lending ladder authorities.
If a board wishes to loosen up on this particular control by shrinking the volume of credit passing through a formal committee process, then it should have a commensurately strong sense that the totality of its systems of internal credit control are strong and consistent.
In a long lending career, I've seen a lot of "credit cowboys. "
They can thrive anywhere depending on the culture. But somehow they seem more at home in the lending ladder environment.
I'm not a total apologist for credit committees, but changes made to delegated lending authorities should be thought through carefully. Unintended consequences to the level of credit risk and the curbing of the tendency of some among us to consider themselves "legends in their own minds" should be paramount objectives in this process.
About Ed O'Leary:
Veteran lender and workout expert O'Leary spent more than 40 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending.
O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools.
Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses and has been a frequent speaker in ABA's Bank Director Telephone Briefing series. You can hear free audio interviews with Ed about workouts here. You can e-mail him at
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. O'Leary's website can be found at www.etoleary.com.
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