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Recently, two members of Ardmore Banking Advisors’ Senior Leadership Team had the privilege of attending the Loan Review Department Managers Forum, presented by RMA (now ProSIght) in Tempe, Arizona. Ardmore’s Executive VP, Peter Cherpack, and Senior VP, Risk Management & Senior Director of Consulting, Todd Sardich, joined representatives from 14 banks nationwide to discuss managing a bank’s loan review function and the issues impacting loan review most in the current economic climate.

What follows is a summary of the key topics discussed at the Forum.

“The opinions discussed are those of the Forum participants for general informational purposes only, and does not constitute professional advice of any kind.”

During the forum, Ardmore made a presentation on management and board reporting for loan review departments. This presentation was based on a survey sent out to more than 30 present and past attendees of the forum, asking about what they reported to management and the Board, and how that information was communicated. More than half of the banks surveyed responded to the survey, with about two-thirds using an all-internal loan review model, and more than half reporting directly to the Board of Directors.

Some key findings include:

• A strong consensus around topics/items reported and typical metrics used: Most reported on a selection of Key Risk Indicators and Credit Metrics, and credit ratings of the current exams with comparisons to previous ones. Many also reported on changes in overall bank risk and progress toward department goals.
• All reported downgrades and policy exceptions, while most are reporting on covenant compliance, Weighted Average Risk Rating and administrative exceptions by bank segment.
• Relatively few banks were using automated summary reporting as a source for their board and management reporting, suggesting that very few respondents had an automated Loan Review system. Most created their reports manually, using data from their bank’s core system, loan portfolio analysis and their own manually tallied results from loan review exams as the source for their reporting.
• An example of scorecard metrics was explored in detail, which included a list of metrics by category. Categories included asset quality, portfolio management, risk recognition, exceptions and qualitative factors like market/economic and industry.

At the end of the presentation, examples of basic and advanced loan review reports were presented and discussed with the Forum members. Some of the advanced reports showed both leading and lagging indicators of risk, which is evolving to becoming an industry best practice.

OCC’s Fall Semi-Annual Risk Perspective

Two members of the OCC made a presentation focused on the most recent OCC SARP (Semi-Annual Risk Perspective). Some specific points of note:

• 2024 saw some moderation in credit risk, but bankers should guard against complacency.
• Commercial credit risk is considered moderate overall though there are still pockets of risk based on market and region. Not surprisingly, this relates to CRE in particular, which is a stressed market.
• Uncertainly is the word of today with residential, credit card and auto loans all reacting to the uncertainly.
• Tariffs are certainly an issue driving uncertainty. The last time the cost of steel skyrocketed, contingency budgets for construction projects were not sufficient, and it appears that most costs for supplies will go up. Travel will certainly be impacted, as will transportation and cross-border trade. Large retailers are already feeling the impact of the tariffs.
• From a CRE perspective, while occupancy rates are slowly growing, the vacancy rate still sits at 14% nationwide. It appears that further occupancy and job growth is currently stalled. Vacancy looks to peak in 2026 then slowly decline. Multi-family is another area of concern, with vacancy rates slowly growing in that segment.
• Inflation risk is still significant.
• Retail appears to be doing surprisingly well, with retail bankruptcy at an all-time low.
• The latest efforts in Washington, DC to cut staff and real estate holdings will have a significant impact on that region’s economy.
• A prudent risk management process and an industry best practice is multiple variable stress testing – both on individual CRE projects and at a portfolio concentration segment level. Using multi-variable stress models like NOI/Property Value and Interest Rate are particularly valuable now with growing uncertainty. The level of sophistication of the stress testing models should be tailored to the risk and complexity of the bank’s portfolio.
• The agency is now focusing on CRE risk (specifically refinance risk), looking for banks to have robust stress testing programs, as well as looking at agricultural lending (tariffs), insurance risk, growth of private capital in lending, and review of current ACL methodologies.

Breakout Group Notes (Smaller Banks) $1 – 10 Billion in Size (approx.)

During session breakouts, Ardmore participated in a group of bankers at institutions between $1 and $10 billion in asset size. Here are some of the most discussed issues:

Relationship with the first line – The group discussed the relationship with lending and the need to avoid a “gotcha” mentality. Ideally, they want to position Loan Review as trusted advisor and a valued resource. They appreciate when the first line reaches out to Loan Review asking how they would handle a situation. One banker reported that they gave every line sheet/work paper back to the first line, so they could read and file it, while most of the others only gave out the line sheets for those borrowers with “findings” in the exam.

Administrative Exception Management – Most in the group agreed that missing financial statements were the top issue they encountered, and the main source of administrative exceptions. Some will even note in their exam if the financials aren’t in the file initially and the lender sends it in later.
A significant source of exceptions is documentation of covenant compliance. One banker commented on how it appeared that a number of lenders would do some rudimentary testing of compliance, and if it looked OK, they would just move on without evidence in the file that the covenant was tested. Another banker said that in their bank this wasn’t much of a problem, as the covenant testing was shown on the annual review documentation. All agreed that different cultures at different institutions contributed greatly to compliance, filing and other administrative issues. If there is no consequence or enforcement of administrative policies, they won’t get followed.

Other sources of exceptions included missing collateral documentation, missing facility ratings (banks with dual risk rating), and follow-up on approval conditions that the loan officer was charged with completing at origination.

Document Review – There was a brief discussion of document review, with some participants doing it in depth and with others taking more cursory looks at key source documents against the loan agreement for inconsistencies. Some have internal loan operations document review functions. One banker commented that they will note issues, but usually not make a finding out of it because they “don’t want to be the document police.”

Using Scorecards – The group talked about scorecards and how some use them and others don’t. One banker said that they have 26 different scorecards – one for every type of loan. Another said their scorecards are based on the main source of repayment. There was a discussion about how the term “scorecard” means different things to different people. Larger banks use origination tools like “Moody’s Credit Lens” which creates the risk rating(s) using complex scorecards, while others use simple matrices of loan/borrower characteristics for determining the risk rating, which they also call a scorecard. Still others used metrics and risk indicators to “score” the amount of risk and/or credit administration for each borrower, rolled up to the segment reviewed.

Targeted Exams and “Lite” Reviews – Bank structure seemed to have an impact on whether institutions use mostly targeted or risk-based reviews. Those banks structured by line of business generally used samples of each line of business to cover all aspects of risk, while others structured along regions had more sampling options to work with. Most said that they had the flexibility to create a risk targeted review if so directed by management or if they felt there was an area that represented emerging risk. Many leave the fourth quarter sampling criteria pretty open to allow for flexibility and clean-up during that time.

Those banks that conducted a portfolio risk assessment would use the results of that assessment to help direct their risk-based review planning. The formal risk assessment is a best practice for mid and larger banks, and something the examiners are typically looking for in their exams.

The idea of having different levels of loan review in the portfolio was discussed, with one banker saying he had a “Lite Review” which had less scrutiny of documentation and is more focused on credit quality. As it turned out, most of the reviews were “Lite” and only 10% were what he considered to be “Full”. The “Full” were designated by the size of the loan, with those over $10 million getting a deeper dive. Most of the rest of the group just used one form for all.

AI in Loan Review – The breakout group discussed a recently released Loan Review solution using an AI “Co-Pilot”. One member of the group had attended a product call, discussing this new tool and its capabilities. From what the banker could tell, it will allow you to import your line sheets and then create a list of questions to ask the lender or try to answer yourself about the borrower from reading the loan files. The questions were based on the loan and borrower characteristics in the line sheet. It wasn’t clear what the knowledge base was that the AI tool was drawing its conclusions from, though it sounded like a CHAT GPT type solution. On the face of it, it seemed that this, or similar solutions, could be valuable training aids, though it is not clear if a bank’s particular lending practices and policies influenced the recommendations from the tool.

Managing Loan Review with New Verticals – The final area of discussion focused on the difficulty in being an expert in all lending verticals of the bank. Some of the loan review managers stated that they get new verticals all the time and this was a challenge, due to unfamiliarity with the credit impact. One larger bank manager said that his bank had a research team that helped loan review analysts learn the new loan/borrower types. Others suggested that you should work with your lenders to better understand their borrowers, risk characteristics and underwriting criteria. Some managers said they task a member of the team to find all the information they can on the vertical and become the department’s source of information. Finally, it was pointed out that one of the advantages of using third-party loan review firms was that they often had experts in many different lending verticals and could call in experts on specific areas as needed.

Risk Rating Practices and Policy Exceptions
Few attendees at the forum used dual risk ratings with most using only the borrower rating on a 1 – 9 scale. Some have expanded the pass ratings to be more granular. One $10B bank said they were considering dual risk rating (DRR) now, considering it an extension of the CECL classifications of their portfolio. There was a discussion of the use of watch lists and watch ratings, and how long a loan should be so classified. The concept that the risk rating should be based only on the primary source of repayment was also discussed. Some felt that LGD (loss given default – based on guarantor and collateral support) was considered to be secondary or even tertiary in importance. One banker mentioned that they sometimes make the guarantor a co-borrower to make the borrower risk rating more holistic, but another banker said their examiner warned against that. There was a brief discussion about no recourse loan structures and carve-outs and how they use them.

The concept of “who assigns the risk rating at the bank” was discussed. Some said they (Loan Review) had complete control, while others had a more collaborative practice with credit and the line. Still others simply approved or denied the risk rating assigned by the lender. One banker said all of his bank’s new loans were graded pass by default, unless they were approved with policy exceptions. Another said that the rating was assigned by committee, but the Loan Review department had veto power. Yet another said that at their bank, the CCO used to have the final say, but that role had been recently passed on to Loan Review.

One banker stated that if the loan officer was unhappy with a rating, Loan Review would listen to the rationale and document it, but at the end, Loan Review still had the final say. He would work closely with the CCO, but also every loan with a policy exception at approval would automatically be sent for a second review. 10% of his approved loans had policy exceptions. Several bankers reacted that 10% was very low and they had 50% up to 70% with policy exceptions, but the exceptions were “reasonable”. There was further discussion that if that many loans have exceptions, maybe the loan policy should be revised instead. Main policy exceptions discussed were: Longer amortization periods (CRE) 25/15, extended absorption for construction projects, and limited or no guarantees.

One banker said they have seen an uptick in policy exceptions recently, but she had attributed that to new lenders coming on board. Another banker at a more rural institution said that the practice in their bank was for loan review to “pre-risk grade” all loans. They explained that in their area, all lending was relationship-based and they would even book special mention loans based on the borrower’s history with the bank and the loan’s characteristics (he referred to “multi-generational family lending”). They would be on special mention for the first 6 to 12 months, and managed by special assets.

On Financial Statements – One banker asked about missing financial statements, asking how long do you wait if the borrower was paying as agreed. Do they really want these customers as borrowers if they won’t provide their financial information? Some cited the competitive pressure for this, and for extending delivery periods and longer amortizations.

A couple of the forum attendees said they put incentives in their loan agreements such that if they don’t get financial statements, they can raise the interest rate on the loans. They reported that they had some borrowers that simply accepted the higher interest rate and continued to pay for a long time or until payoff.

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