Tracking Loan Documentation Exceptions
Federal bank and credit union examiners insist that a reliable system for tracking exceptions needs to be part of any loan portfolio management process. And tracking deviations from the loan policy and underwriting standards is certainly crucial. But often, it’s analyzing and controlling exceptions related to documentation that can alert a financial institution when a loan deviates from those standards.
On the surface, documentation exceptions may seem minor or less important than exceptions to underwriting policies when it comes to loan tracking. Yet, missing, stale or improperly executed documents can, according to the Office of the Comptroller of the Currency’s Loan Portfolio Management Handbook, “exacerbate problem loans and seriously hamper work-out efforts.”
For example, when a financial institution doesn’t ensure that it receives and reviews financial statements or tax returns in a timely manner, it can miss out on opportunities to identify potential problems and to take steps to avoid or mitigate those issues. Or, the institution may identify covenant violations late, which could jeopardize its ability to enforce the loan agreement.
If a financial institution fails to renew a Uniform Commercial Code (UCC) financing statement to give notice of its interest in a debtor’s property, the credit could transition from secured to unsecured. In a $2.1 million foreclosure lawsuit last year, Bank of America acknowledged it had lost a loan agreement with the property’s owner, according to a published report.
Here are four tips to improve your portfolio loan management through better exception tracking:
Systematically identify document exceptions. Many financial institutions may find it difficult to identify exceptions in a systematic and routine way if much of the documentation is contained in physical credit files or is tracked using spreadsheet programs such as Excel. It’s important to develop a system for tracking collateral, customer correspondence and other items in a way that multiple users can readily retrieve and update the information. Be cautious when relying on spreadsheet-housed data, which can be prone to more manual and formula errors than if the data were captured in the core or other automated software systems used for analyzing borrower financial data.
Initiate timely resolution of document exceptions. Resolving document exceptions can be time consuming and costly, given the sheer number of documents that may be monitored on an ongoing basis. But it’s important to address them quickly in order to minimize potential losses.
Ensure that documentation remains valid and current throughout the loan term. Identifying documentation exceptions before the loan closes is obviously preferable, but sound loan administration and risk management is an ongoing process. Conduct post-closing reviews and periodic checks by developing tickler, or reminder, systems and by using automated systems to generate client emails, letters or phone lists.
Analyze patterns in document exceptions. Identifying patterns can point out problems in the origination process, which may prompt changes that can make loan approvals more efficient. Identifying patterns may also help single out staff or business units that need to strengthen documentation compliance. Reports to management are only as useful as the analysis and improvements generated from the data.
Examiners understand the importance of document exceptions in evaluating the quality of the financial institution’s lending policies and loan portfolio management. The FDIC’s Risk Management Manual of Examination Policies says that weak loans manifest themselves in a variety of ways but specifically notes that examiners may be able to identify potential problem loans during examinations by finding evidence of missing or inadequate collateral or loan documentation. This means it’s critically important for financial institutions to work toward improving the document exception aspect of loan portfolio administration.