![CFA Leaders Recommend Return to Credit Basics David J. Kantes, Senior Vice President and Chief Risk Officer, Siemens Financial Services, Inc. - “ Faced with perhaps the worst recession since the 1930s, ‘secured lenders’ are again relearning the lessons from the past 65 + years.” (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )](https://image.slidesharecdn.com/underwritingschangingrolefinalshare-12757059993403-phpapp01/85/CFA-Underwritings-Changing-Role-18-320.jpg)
![CFA Leaders Recommend Return to Credit Basics Michael D. Sharkey, President of Cole Taylor Business Capital - “ Once again sound ABL fundamentals and execution will be key to a successful outcome.” (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )](https://image.slidesharecdn.com/underwritingschangingrolefinalshare-12757059993403-phpapp01/85/CFA-Underwritings-Changing-Role-19-320.jpg)
![John Kiefer, CEO, First Capital - “ Although times may have changed and credits have become much more complicated and complex, the principles and fundamentals of credit analysis basically boil down to the three C’s of credit analysis, which have served me throughout good times and bad.” CFA Leaders Recommend Return to Credit Basics (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )](https://image.slidesharecdn.com/underwritingschangingrolefinalshare-12757059993403-phpapp01/85/CFA-Underwritings-Changing-Role-20-320.jpg)
![Norman Smith Vice President Manager-ABL Underwriting and Portfolio Development Mount Laurel, NJ 08054 Phone: 856-813-2660 Mobile: 856-308-4110 Fax: 800-352-1231 [email_address] My blog, the Lenders’ Café : http://normansmith.wordpress.com Visit CFA’s Group on www.Linkedin.com](https://image.slidesharecdn.com/underwritingschangingrolefinalshare-12757059993403-phpapp01/85/CFA-Underwritings-Changing-Role-42-320.jpg)
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CFA Underwritings Changing Role
- 1. THE ROLE OFTHE UNDERWRITER
- 2. The term, “Underwriting”,derives from the Lloyd's of London insurance market. Lloyd’s financial bankers, who would personally accept some of the risk on a given venture, would literally write their names under the risk information which was written on a Lloyd's slip created for this purpose. At its core, Underwriting means two things that an investment professional performed a realistic evaluation of the investment situation and fully understands the risk the investment professional is willing to make a recommendation on how to deal with the risk and is willing to take personal accountability for its success.
- 3. THE ROLE OFTHE UNDERWRITER 30 Years of Financial Crises Basic Credit Standards Evolution of Underwriting Driving Better Risk Management Through Credit Culture and Compensation
- 4. Characteristics of aBubble Abundant capital chasing higher investment returns Uncontrolled growth of a sector Lack of Fear – irrational exuberance Leverage
- 5. 1980’s 30 yearsof Bubbles CommercialReal Estate Boom Commercial Real Estate Bust Over-emphasis on up-front fees Loosening of underwriting standards Increase in leverage Irrational expectations as to collateral value` THE S&L CRISIS!
- 6. 1980’s 1990’s TechBoom/ Dot-Com Bubble 30 years of Bubbles CommercialReal Estate Boom Commercial Real Estate Bust The TECH BOOM/BUST Venture Capitalists ignored normal diligence Irrational expectations about future profitability Irrational expectations about the economy 2000’s Dot-Com Bust 9/11/2001
- 7. 1980’s 1990’s 2000’sTech Boom/ Dot-Com Bubble Dot-Com Bust 9/11/2001 Greenspan Lowers Fed Funds to 1% Real Estate Boom Real Estate Bust Credit Crisis 30 years of Bubbles CommercialReal Estate Boom Commercial Real Estate Bust
- 8.
- 9. G-20 Leaders Summit November 15, 2008 “Declaration of the Summit on Financial Markets and the World Economy” “ During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system.”
- 10. Excerpts from Office of the Comptroller of the Currency (OCC) 15th Annual Underwriting Survey 2009 The survey covers the 12-month period ending March 31, 2009. ( http://www.occ.treas.gov/cusurvey/2009UnderwritingSurvey.pdf ) 59 Largest National Banks ($3B+ of assets) $3.6T of Loans 84% of total loans in National Banking System
- 11. 2009 OCC UnderwritingSurvey Overall Commercial Credit Underwriting Trends Source: ( http://www.occ.treas.gov/cusurvey/2009UnderwritingSurvey.pdf ) Tightened!!
- 12. 2009 OCC UnderwritingSurvey Source: ( http://www.occ.treas.gov/cusurvey/2009UnderwritingSurvey.pdf ) Tightened
- 13. Excerpts from Office of the Comptroller of the Currency (OCC) 15th Annual Underwriting Survey 2009 The survey covers the 12-month period ending March 31, 2009. ( http://www.occ.treas.gov/cusurvey/2009UnderwritingSurvey.pdf ) Financial market disruption continues to affect bankers’ appetite for risk Renewed focus on fundamental credit principles by bank lenders. Banks tighten credit standards, become more conservative in their lending practices Factors continuing to impact lending practices: Weaknesses in the economy Lack of secondary market liquidity Less competition Declining portfolio quality
- 14. THE FDIC SPEAKSIssues Contributing to the Credit Crises : Competitive relaxation of credit standards to gain and maintain revenue growth. Traditional lending standards can appear an unnecessary impediment to revenue growth. Underwriting weaknesses : Contributed to investor uncertainty about the quality of bank assets Amplify the adverse impact of the economic downturn on bank performance. Summary of comments from George French, Deputy Director of Supervision and Consumer Protection in, FDIC Supervisory Insights, Summer 2009, Vol. 6, Issue 1
- 15. THE FDIC SPEAKS“ A decline in loan underwriting standards belongs on any list of the factors responsible for the current crisis.” Summary of comments from George French, Deputy Director of Supervision and Consumer Protection in, FDIC Supervisory Insights, Summer 2009, Vol. 6, Issue 1
- 16. Protecting the FutureBack to Basics
- 17. Lessons Learned Underwrite as if you are going to hold the entire deal Know your Counterparties and Loan Participants Fully understand (meaning underwrite) the risk of credits you buy into Make loans that can be repaid Require Equity
- 18. CFA Leaders RecommendReturn to Credit Basics David J. Kantes, Senior Vice President and Chief Risk Officer, Siemens Financial Services, Inc. - “ Faced with perhaps the worst recession since the 1930s, ‘secured lenders’ are again relearning the lessons from the past 65 + years.” (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )
- 19. CFA Leaders RecommendReturn to Credit Basics Michael D. Sharkey, President of Cole Taylor Business Capital - “ Once again sound ABL fundamentals and execution will be key to a successful outcome.” (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )
- 20. John Kiefer, CEO,First Capital - “ Although times may have changed and credits have become much more complicated and complex, the principles and fundamentals of credit analysis basically boil down to the three C’s of credit analysis, which have served me throughout good times and bad.” CFA Leaders Recommend Return to Credit Basics (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )
- 21. Back to BasicsThe Five “C’s” of Credit Character Capacity Capital Conditions Collateral Source: Dev Strischek, The Five C’s of Credit, The RMA Journal, May 2009, 34 - 37
- 22. Credit Culture Acommon credit language is spoken throughout the bank, with candor and good communication at every level. There is understanding and respect for the credit basics. Each lending officer understands what the bank expects and is aware of the effect of his or her credit decisions on the entire organization. The credit system has checks and balances to give early warning of deviations. There is accountability for decisions at all levels. There is flexibility, but not looseness, in dealing with exceptions to policy. Concern for the continued health and success of the institution is placed ahead of profit center concerns. The incentive system takes into account long-term results, not just immediate profits. Bonuses don’t drive people in wrong directions. Source: Mueller, P. Henry, “Trees Don’t Grow to Heaven”, The RMA Journal , December 2008 – January 2009, 53-59
- 23. Evolution of UnderwritingAnd The C hanging Role of the Underwriter
- 24. Evolution of UnderwritingAncient History (prior to 1990’s): Commercial Lender (Relationship/Account Manager) Did It All
- 25. Evolution of UnderwritingLender Does It All Pros: Know your customer Lender’s knowledge of all aspects of the deal (credit, operational, documentation) Lender judged on his/her portfolio’s performance Cons: Lender’s experience and training is key variable Lender may get to close too customer; lose objectiveness May be inefficient - Focus on business development? Focus on credit? Focus on customer relations/account management? (Enough time to do it ALL?)
- 26. Evolution of UnderwritingRecent History (after 1980’s): Finder, Grinder, Minder Underwriter (Grinder) specializes in evaluating credit worthiness of new borrowers. Other “specialists” focus on business development (“Finder”), customer relations/account management (“Minder”) Deal Origination Underwriting Portfolio Management Credit Quality
- 27. Evolution of UnderwritingFinder, Grinder, Minder Pros: Efficiency Strong focus on specific aspects of deal Focus should lead to higher levels of expertise for each specialist Ability to compensate business developers based on volume of new loans, while minimizing the risk to credit standards Cons: Inefficient “hand-off” of deal between specialists Possible lack of cross-training Implications for organizational evolution (lack of well-rounded training for promoted specialists)
- 28. A New Rolefor Underwriting Bridging Business Development and Credit Culture
- 29. A New Rolefor Underwriting A New Role: Leader of the Deal Team Underwriter manages and leads the Deal Team (after the deal is identified) from proposal to closing Works as a team with Business Development, Field Exam, and Portfolio Management to ensure deal fits the institutions Credit Culture Possible combination of Underwriting and Portfolio Management roles within the Underwriter function Credit Quality Business Development Portfolio Development Underwriting
- 30. Leader of theDeal Team Pros: Efficiency Lender’s knowledge of all aspects of the deal (credit, operational, documentation) Lender judged on his/her portfolio’s performance Cons: Lender may get to close to customer; lose objectiveness Additional duties can slow down the overall process Lender’s experience and training
- 31. Leader of theDeal Team Is he/she on your team now? If not, can you develop in-house talent?
- 32. Leader of theDeal Team Required Skill Set Strong Credit Skills Strong People Skills Strong Negotiation Skills Strong Technology Skills Strong Work Ethic Self-Starter, Able To Work Independently
- 33. Leader of theDeal Team Experienced Underwriter Strong credit skills Usually has strong technology skills Usually has strong negotiation skills Usually has strong people skills
- 34. Leader of theDeal Team Experienced Account Executive Strong credit skills Negotiation skills Has (or has potential to develop) people skills Usually has strong technology skills
- 35. Leader of theDeal Team Business Developer Strong people skills Negotiation skills Willing to trade stability of compensation for upside potential Has (or has potential to develop) credit skills Willing to become proficient with technology
- 36. Leader of theDeal Team Experienced Field Examiner Has (or has potential to develop) credit skills Usually has strong technology skills Has (or has potential to develop) negotiation skills Has (or has potential to develop) people skills
- 37. Credit Culture &Compensation Evolution of Underwriting Everybody Owns The Risk
- 38. Brian Peters, SVPRisk Management, JP Morgan Chase, July 2009 RMA New York Chapter Roundtable Credit Culture & Compensation Create incentives for people to have a longer view of the firm, to optimize not just the return side of risk adjusted return but also to minimize the risk and create value that way. Firms that failed overemphasized the return. Firms that succeeded put equal weights on return and risk. Evolution of Underwriting
- 39. Credit Culture &Compensation Everybody Owns The Risk Evolution of Underwriting Compensation Long Term Horizon Encourage Profitable Growth Salary Bonus How Much? Paid Over Time Period Performance Tracking and Review
- 40. Credit Culture &Compensation Example Performance Goal: “ Accomplishment of the goal will be measured by completion and presentation by the underwriter of a written approval request for all new loan requests assigned to the underwriter by the Underwriting Manager. Approval documents will conform to the form and format utilized by {the institution} and will be completed in a time frame allowing for review and acceptance by the Underwriting Manager by {appropriate time} the day before presentation to the approval committee. The presentation will occur within sufficient time to allow funding of the deal within the time frame expected by the borrower.” Evolution of Underwriting Performance Tracking and Review
- 41. Training Commercial FinanceAssociation: https://www.cfa.com Risk Management Association: http://www.rmahq.org American Management Association: http://www.amanet.org/ American Institute of Certified Public Accountants (AICPA): http://aicpa.org Evolution of Underwriting
- 42. Norman Smith VicePresident Manager-ABL Underwriting and Portfolio Development Mount Laurel, NJ 08054 Phone: 856-813-2660 Mobile: 856-308-4110 Fax: 800-352-1231 [email_address] My blog, the Lenders’ Café : http://normansmith.wordpress.com Visit CFA’s Group on www.Linkedin.com
Editor's Notes
- #10 The Office of the Comptroller of the Currency (OCC) conducted its 15th annual underwriting survey to identify trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks. The survey covers the 12-month period ending March 31, 2009. This is the most recent survey available. The 2009 survey includes examiner assessments of credit underwriting standards at the 59 largest national banks with assets of $3 billion or more. This population covers loans totaling $3.6 trillion as of December 2008, approximately 84 percent of total loans in the national banking system.
- #11 The Office of the Comptroller of the Currency (OCC) conducted its 15th annual underwriting survey to identify trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks. The survey covers the 12-month period ending March 31, 2009. This is the most recent survey available. The 2009 survey includes examiner assessments of credit underwriting standards at the 59 largest national banks with assets of $3 billion or more. This population covers loans totaling $3.6 trillion as of December 2008, approximately 84 percent of total loans in the national banking system.
- #12 The Office of the Comptroller of the Currency (OCC) conducted its 15th annual underwriting survey to identify trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks. The survey covers the 12-month period ending March 31, 2009. The 2009 survey includes examiner assessments of credit underwriting standards at the 59 largest national banks with assets of $3 billion or more. This population covers loans totaling $3.6 trillion as of December 2008, approximately 84 percent of total loans in the national banking system. Large banks referenced in the subsequent comments are the 15 largest banks by asset size supervised by the OCC’s Large Bank Supervision department; the other 44 banks are supervised by the OCC’s Midsize/Community Bank Supervision department. This year’s survey indicates that the majority of banks now use generally the same underwriting standards regardless of the intent to hold or distribute. A key lesson learned from the financial market disruption is the need for bankers to apply sound, consistent underwriting standards regardless of whether a loan is originated with the intent to hold or sell. The OCC reminds bankers that underwriting standards should not be compromised by competitive pressures or the assumption that the loan will be sold to third parties. The financial market disruption continues to affect bankers’ appetite for risk and has resulted in a renewed focus on fundamental credit principles by bank lenders. For the 12 months covered by the 2009 survey, examiners reported tightening of underwriting standards in 86 percent of the surveyed banks compared with 52 percent in the 2008 survey. The tightening of standards reported in the last two surveys reflects concerns about unfavorable external conditions and product performance. On a product-by-product basis, tightening was most significant for commercial real estate, large corporate, middle market, small business, residential real estate, home equity, and indirect products. Once again, examiners reported that the surveyed banks used pricing as their primary method to modify underwriting standards for commercial products. However, loan covenants and collateral requirements were also used to tighten standards. Covenants, as well as other structural underwriting criteria, afford banks a greater measure of control in managing credit risk. Underwriting standards tightened for all commercial loan products surveyed. The most prevalent tightening occurred in CRE loans, middle market, small business, and large corporate loans. Examiners reported a few isolated instances of eased commercial credit underwriting standards in asset-based and other CRE products. Originate to Hold Versus Originate to Sell This is the second annual survey to assess the differences in underwriting between loans originated to hold in the banks’ own loan portfolios and loans originated to sell in the marketplace. Of the 59 banks surveyed, 29 percent originated loans both to hold or to sell. In this year’s survey, examiners indicate that the majority (86 percent) of the banks originated loans in the various product lines with generally the same underwriting standards regardless of intent to hold or distribute. When standards differed, banks typically mitigated risks of loss through conservative limits on exposures held. These limits were breached in some banks when secondary market liquidity declined. The most notable difference in underwriting standards in this year’s survey is for leveraged loans. While most leveraged loans underwritten with the intent to sell were underwritten on the same terms as those held for investment, examiners observed a higher incidence of leveraged loans underwritten differently than was observed for other loans types. New leveraged loan volume was low in the 2009 survey. Examiners noted that loans underwritten in the current market were generally more conservatively underwritten as evidenced by reduced leverage, higher debt service coverage, and increased loan covenants. The continued tightening of underwriting standards for all loans, whether intended for sale or investment, is a direct result of changes in the economic outlook and market liquidity.
- #13 Asset based lending my be the area that rebounds the fastest and grows the most over the next 3 years.
- #14 The Office of the Comptroller of the Currency (OCC) conducted its 15th annual underwriting survey to identify trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks. The survey covers the 12-month period ending March 31, 2009. This is the most recent survey available. The 2009 survey includes examiner assessments of credit underwriting standards at the 59 largest national banks with assets of $3 billion or more. This population covers loans totaling $3.6 trillion as of December 2008, approximately 84 percent of total loans in the national banking system.
- #15 Any commercial bank , and even traditionally non-bank lenders that opted to change to bank holding company status during the recent crisis, should consider the FDIC an important constituency. The FDIC issues numerous …….. Supervisory Highlights is published periodically by the FDIC and contains several articles intended to promote best practices of bank supervision, and thereby, bank management. Following is an excerpt from the introduction to the Summer 2009 issue: In the annals of bank supervision, 2008 will be remembered as a year in which some old assumptions were shattered and some old truths relearned. Some of the old banking basics— prudent loan underwriting, strong capital and liquidity, and the fair treatment of customers—re-emerged as likely cornerstones of a more stable financial system in the future. Comments from George French, Deputy Director, FDIC Division of Supervision and Consumer Protection A look back on the buildup to the financial crisis reveals similarities to earlier cycles of boom and bust. During the expansion, financial firms engage in a competitive relaxation of credit standards and risk tolerances to gain and maintain revenue growth. Easy credit allows borrowers to refinance ever-greater obligations in lieu of repayment, driving down default rates. This fuels the perception that credit risk is minimal, stimulating further loosening of credit terms in a self-perpetuating cycle. To some banks operating in such an environment, traditional lending standards can appear an unnecessary impediment to revenue growth. To varying degrees, subprime mortgages, other consumer loans, construction loans, loans to leveraged corporate borrowers, and commercial real estate loans, have all exhibited weakness in underwriting standards. Underwriting weaknesses have contributed to investor uncertainty about the quality of bank assets and amplified the adverse impact of the economic downturn on bank performance. A decline in loan underwriting standards belongs on any list of the factors responsible for the current crisis.
- #16 Deputy Director French also had this warning for regulated institutions: Over the years, the banking agencies have issued a number of supervisory guidance documents regarding adverse credit risk trends. These guidance documents indicate that the agencies were generally aware of, and concerned about, emerging potential credit risks. A future focus of supervision in responding to such emerging risks may well include a careful look at where the line should be drawn between guidance and informal supervisory expectations on the one hand, and more tangible requirements on the other. Ignore this FDIC warning at your own risk – - Cease and Desist Orders, other negative regulatory consequences for the institution
- #21 Three C’s of Credit – Character, Capital and Capacity