5 Strategies for Loan Review in Current Credit Market

The lending environment is undergoing a seismic shift, with interest rate fluctuations and pockets of softening in economic conditions reshaping the landscape. As loans originated between 2017 and 2022 come up for renewal, financial institutions are grappling with the implications of higher interest rates on these transactions. During our recent “Financial Services Audit Committee Overview” webinar, we covered the current credit market as well as five strategies for effective credit risk management in the face of continued turbulence.

Borrowers’ ability to meet their obligations might be affected by the current credit and economic landscape, as it’s marked by rising interest rates, inflationary pressures, and shifting economic dynamics. To succeed in this turbulent environment, institutions must adopt a comprehensive approach that emphasizes frequent borrower information gathering, timely annual reviews, monitoring of leading risk indicators, and an independent loan review program that is both effective and dynamic. Risk rating activity is evolving in these times, so being proactive on each of these pieces will help institutions keep risk ratings more up to date and timely.

Institutions can no longer rely on basic financial statements or outdated data. In today’s fast-paced market, having access to the freshest information is vital for institutions to accurately assess credit risk. Institutions should prioritize collecting current financial statements, rent rolls, and other relevant data from borrowers on a regular basis. This information enables early detection of potential issues and allows institutions to make informed decisions about risk ratings and loan renewals.

Institutions should conduct loan reviews at least annually, but ideally on a more frequent basis for loans of a meaningful size or risk profile, to help identify opportunities for risk mitigation. These reviews should incorporate both historical performance data and forward-looking projections to get a complete picture of the loan and its effect on the institution. By thoroughly analyzing cash flows, implied cap rates, and other key metrics, institutions can better understand the potential risks and opportunities associated with each loan. It also is important to regularly have site visits to the client and collateral properties with documentation of findings from these visits on file.

Tracking trends in areas such as consumer debt levels, personal savings rates, and sector-specific performance can help institutions stay on top of leading risk indicators. By identifying potential risks before they fully materialize, institutions can proactively manage their loan portfolios and help mitigate potential losses.

Especially with constant shifts in the market, institutions need to continually evaluate and challenge their loan review programs. This looks different for every institution but might involve increasing coverage in high-risk areas, conducting deeper dives into specific products or portfolios, or exploring new technologies and visualization tools to enhance risk monitoring capabilities. Regular training on risk rating methodologies and best practices also should be a priority, as these help equip loan review teams with the latest knowledge and skills.

These strategies can help financial institutions navigate the turbulent credit markets with confidence. By effectively identifying and managing risks, institutions can help position themselves for long-term success in an ever-changing lending environment.