Managing Lending Risk - ACUIA 13... · • Gain an understanding the types of controls that should...
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Managing Lending Risk Presented by: Carrie Kennedy, CPA, Partner Anthony Porter, CPA, Manager
Transcript of Managing Lending Risk - ACUIA 13... · • Gain an understanding the types of controls that should...
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Managing Lending RiskPresentedby:CarrieKennedy,CPA,PartnerAnthonyPorter,CPA,Manager
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Thematerialappearinginthispresentationisforinformationalpurposesonlyandshouldnotbeconstruedasadviceofanykind,including,withoutlimitation,legal,accounting,orinvestmentadvice.Thisinformationisnotintendedtocreate,andreceiptdoesnotconstitute,alegalrelationship,including,butnotlimitedto,anaccountant‐clientrelationship.Althoughthisinformationmayhavebeenpreparedbyprofessionals,itshouldnotbeusedasasubstituteforprofessionalservices.Iflegal,accounting,investment,orotherprofessionaladviceisrequired,theservicesofaprofessionalshouldbesought.
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ABOUT MOSS ADAMS LLP
• Full‐servicepublicaccountingfirmwithassurance,tax,andconsultingservicesformiddle‐marketpublicandprivatecompanies
• Oneofthe15largestaccountingfirmsintheU.S.andlargestfirmheadquarteredontheWestCoast
• 22officesinArizona,California,Kansas,NewMexico,Oregon,andWashington
• Foundedin1913andheadquarteredinSeattle,Washington
• Wearethe4thlargestfirmservicingcreditunionsinthenation(basedonassets)
• FoundingmemberofPraxity,aglobalallianceofaccountingfirms
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PRESENTERSCarrieKennedy,CPA,PartnerCarriehaspracticedpublicaccountingsince1997.Sheperformsinternalauditoutsourcing,supervisoryaudits,annualopinionaudits,loanreviews,andSECreportingengagements.CarrieisamemberoftheFinancialServicesGroupandprovidesauditandbusinessassuranceservicestoher20creditunionandfinancialinstitutionclients.Herexperienceincludesfinancialandoperationalaudits,withrelatedmanagementrecommendationsforcostsavingsandefficiencyimprovements; loanfilereviewandevaluation;numerousrecurringauditsoffinancialstatements;assistance,preparation,andreviewofSECregistrationstatements,includingFormsS‐1,S‐4,andForms10,10‐K,10‐Q,and8‐Q;andemployeebenefitplanauditsandqualificationstatusreviews.
AnthonyPorter,CPA,ManagerAnthonyhasbeeninpublicaccountingandwithMossAdamsforsixyearsworkingwithfinancialinstitutions.Hemanagesfinancialandoperationalaudits,withrelatedmanagementrecommendationsforcostsavingsandefficiencyimprovements.HehasexperiencewithSECfilingsandregistrationstatements,mutual‐stockconversions,andmergerandacquisitionengagements.Heisproficientinallphasesofaudits,includingHUDreporting,Sarbanes‐OxleyandFDICIAcontroltesting,fieldwork,andreportpreparation.Anthonyisalsoinvolvedinthefirm’sFinancialServicesGroup.HereceivedaBAinBusinessAdministrationwithanemphasisinAccountingandaMastersofProfessionalAccountancyfromtheUniversityofWashington.
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OBJECTIVES
• Distinguishbetweenpreventativeanddetectivecontrols
• Gainanunderstandingthetypesofcontrolsthatshouldbeinplaceforastrongcontrolenvironment
• Understandtherisksassociatedwitheachtypeoflending:mortgage,consumer,indirect,andmemberbusiness
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CONTROL ENVIRONMENT
• Whatisthetone?o Ethicaltenorstartsattopmanagementandtricklesdown
o Codeofconduct?
• CreditUnioncancontrol“opportunities”forfraud
• Active,strongcontrolsreducetheopportunitiesavailabletothosewhofindthemselvesinthecircumstancesreferredtoabove.
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CONTROL ENVIRONMENT
• Internalcontrolobjectivesaredesiredgoalsorconditionsforaspecificeventcyclewhich,ifachieved,minimizethepotentialthatwaste,loss,unauthorizeduseormisappropriatewilloccur.Theyareconditionswhichwewantthesystemofinternalcontroltosatisfy.
• Foracontrolobjectivetobeeffective,compliancewithitmustbemeasurableandobservable.
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INTERNAL CONTROLS
• Internalcontrolscanbedetective,corrective,orpreventativeinnature.
o Preventativecontrolsaredesignedtokeeperrorsorirregularitiesfromoccurringinthefirstplace.
o Correctiveerrorsaredesignedtocorrecterrorsorirregularitiesthathavebeendetected.
o Detectivecontrolsaredesignedtodetecterrorsorirregularitiesthatmayhaveoccurred.
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INTERNAL CONTROLS
• Preventativevs.Correctivevs.Detective
o Preventative Strongesttypeofcontrol Largercompanieswithlotsofemployees
o Corrective Notassaspreventative Difficulttoimplement MorecommoninITareas
o Detective Notasstrongaspreventativeorcorrective Smallercompanieswithlimitednumberofemployees BetterthanNO controls
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LOANS – INTERNAL CONTROLS
• Lendingfunctioncanbebroadlydividedintothefollowingcategories:o Originationanddisbursemento Loanreview(QCandCreditQuality)o Creditsupervision/monitoring
• Segregationofdutieso Separatetheunderwriting,disbursement,andboardingprocesses
o Systemcontrols• Preventivemeasures
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LOANS – ORIGINATING AND DISBURSEMENT
• Originating
o ApprovedloanpolicycoveringLTV’s,loantypes,DSC,andother
factors
• Hasitbeenupdatedbasedoncurrenttimes?
‐ Properapprovalauthority
o Approvedappraisers
Orderedbysomeoneotherthanloanofficerorunderwriter
o AppraisalreviewsonALL appraisals
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LOANS – ORIGINATING AND DISBURSEMENT
• Appraisalreviews‐Howareyoucomfortablethe
appraisalcanbereliedupon? Appraisalreviewconductedbyindependentqualified3rd party,
eitherinternalorexternalparty
Usuallya“deskreview”andincludes:
– Descriptionofthepropertyandconclusiononappraisersvalue
– Discussionofkeyassumptionsusedbytheappraiser
– Summaryoftheappraisersfindings
– Ultimateconclusiononvaluecomparedtoappraisersfindings
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LOANS – ORIGINATING AND DISBURSEMENT
• Originatingo Collateralliens UCCsearchesandfilings Filingdeedoftrust Titlepolicies Freezingshares
o Qualitycontrolreviewtoensureallcollaterallienshavebeenperfected
o Ticklersystemforoutstandingdocumentsnotyetreceived
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LOANS – ORIGINATING AND DISBURSEMENT
• Disbursemento Performedbyindividualseparatefromtheorigination/underwritingprocess
o Ensureproceedsareusedfortheborrower’sstatedloanpurpose
o Unabletosegregatedisbursementfunction???
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LOANS – LOAN REVIEW
o Boardingreview
Detectscommonerrorssuchasinterestrateandmaturity
dateerrors
o Qualitycontrolreview
Determinewhetherloansadheretotheloanpolicy
Conductedbypersonnelindependentofcreditfunctions
Don’trelyonyourexternalauditors!
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LOANS – LOAN REVIEW
• CreditQualityReviewo IncreasinginfrequencyatCreditUnionswiththeincreasein
MemberBusinessLending
o Usuallyperformedbyexternal3rd party
o CanbetiedinwithQCloanreviews,butultimatepurposeisto
validatethecreditevaluation/monitoringbytheCreditUnion
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LOANS – CREDIT SUPERVISION/MONITORING
• CommonKeyCreditRiskIndicators
o Delinquency(60+dayspastdue)
o Earlystagedelinquency(1– 59dayspastdue)
o Charge‐offhistory
o FICO/LTV/loangrademigration
o Concentrations
o Multiplemodifications/extensionsandrenewals
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LOANS – CREDIT SUPERVISION/MONITORING
• Questionstoaskregardingmonitoring:
o Istheloanreviewfunctionindependentofthecreditadministrationandloanapprovalprocesses?
o Areanyloanfindingsreporteddirectlytotheboardofdirectorsorboardlevelcommittee?
o Doestheboardreceivenecessaryandreliableinformationonaregularbasistoassessandpotentialriskswithinthelendingportfolio?
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LOANS – CREDIT SUPERVISION/MONITORING
• Questionstoaskregardingmonitoring:
o Areproceduresinplacetoensurethepromptidentificationofloanswithwell‐definedweaknessesandrelevantlendingpatternsthatmaypotentiallybeindicativeoffictitiousorfraudulentactivity?
o Doloanreviewpersonnelhavetheknowledgeandconfidencetochallengetransactionsthatlooksuspicious?
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LOANS – FRAUD CONTROLS
• Commondetectivecontrolstoidentifyerrorsand/orfraudo Reviewlowrateloanreportso Commonaddressreviewo Filemaintenancereportsshouldbereviewedfor:
Advancingpaymentduedates Changesininterestrates Changesofthepaymentamount Severaladdresschangestothesameaddress Changingthepaymentfrequency
o Overdraftreportsreviewedfor: Overdraftscreatedforpurposeof“paying”loan
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LOANS – FRAUD CONTROLS
• Otherfraudanderrordetection
o Largeamountofinterestisdue,buttheloaniscurrent
o Originalloanamountandcurrentloanamountarethesame,buttheloanisnotdelinquent
o Reviewofemployeeandofficialloans
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LOANS – INTERNAL CONTROLS
• Othercontrolstoconsider
o Reconcilingsubsidiariestothegeneralledger
o Globalratechangereview
o Loanexceptionreport
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LOANS – INTERNAL CONTROLS
• Memberstatementsarethefinaldetectioncontrols
o Propercontrolsoverno‐mailandprintsuppressed
o Reconcilingtotalstatementsprocessedtomembers
o Timelyresponsetomemberinquiries
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INDIRECT LENDING
• Whatisit?o Existsindifferentformso Mostcommonformisanarrangementwhereacreditunioncontractswithamerchant(commonlyacardealer)tooriginateloansatthepointofsale.
• Whataretherisks?o Rapidgrowthinanindirectproductlinecanleadtoamaterialshiftinacreditunion’sbalancesheetcomposition.
o Improperlymanagedindirectprogramscanleadtounintendedriskexposureincludingcreditrisk,liquidityrisk,transactionrisk,andcompliancerisk.
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INDIRECT LENDING
• MitigatingRisko Processinplacetoperformduediligenceonthethirdpartyvendorswhichshouldinclude: Aplanningprocesswhichassessestheriskofthevendorrelationshipbothinitially andongoing
Writtenpoliciesaddressingallfacetsofindirectlendingprogramincludingunderwritingandmonitoring
Aprocesstoperiodicallyassessthelegalagreements Areviewprocesstoassessthevendor’sfinancialandoperationalrisks
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INDIRECT LENDING
• MonitoringActivitieso Approval/declineratiosbydealer
o Firstpaymentdefaultsbydealer
o EvaluateALLLlossratios
Separatefromdirectautos
o Earlypayoffsbydealerandincentivespaid
o Loansapprovedbyloanofficer
o Loan‐to‐valuebydealer
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INDIRECT LENDING
• MonitoringActivities‐ Delinquencyrates
• Bydealer• Byloanofficer• Byoriginationdate• Bycreditscore• Bydays– typicaldelinquencyreport
‐ Trackchargeoffsbythesecategoriesaswell
‐ Ratesofreturn/profitabilityanalysisbyvendor
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INDIRECT LENDING
• QualityControlProcess
o Reviewoftheapplication
Isincomeconsistentwiththestatedjob
CreditReport– Comparisonwithapplication
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MEMBER BUSINESS LOANS
• Increasinginfrequencyacrosscreditunions
• Thesearecommercialloansandaremorecomplexthanthetypicalconsumerloano Alsoincludesallparticipatedloans
• TheyareregulatedbyNCUAPart723
• Requiresincreasedunderwritingcontrolsandmonitoring
• Increasedrisk
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MEMBER BUSINESS LOANS
• Therearerestrictionsonloantypesandvolumeofloanso CreditUnionscurrentlylimitedtolesserof1.75xcreditunionnetworth,or12.25%oftotalassets
o Legislationintroducedtoincreasethelimitto27.5%oftotalassets
• Needtomonitorandreportratiostoensurecompliancetobothpolicyandregulatorylimits
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MEMBER BUSINESS LOANS
• UnderwritingIssueso Rightpeoplewithadequateexperience
o Appropriatesegregationandlimitsonapprovalauthority
o Understandinganddocumentationofcashflows(spreads),collateral,guarantees,strengths,andweaknesses
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MEMBER BUSINESS LOANS
• Monitoringo Goodsecondaryreviewprocess Stronglyrecommend3rd partyreview
o Concentrations Typicallycreditunionsaregeographicallyandmemberoccupationconcentrated.Isthereproductconcentrationtoo?
o MonitoringLTV’sandfuturematuritiesofcollateraldependentloans
o Morepronetoextensions,renewals,anddelinquencies PotentialTDR’s
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MEMBER BUSINESS LOANS
• Participationspurchased‐ Purchaseroftenreliesontheworkperformedbyotherinstitution
• Purchasesofmorethan50%shouldberare!‐ Monitoringismuchmoredifficult
• Knowtheparticipatinginstitution‐ Substantiallosseshaveoccurredhereandforeclosuresgetmessy
• Participationlosseshavegrown
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MEMBER BUSINESS LOANS
• Allowanceforloanlosses
o Loangrading
3rd partycreditreview
o Impairmentanalysis
Policyonfrequencyofanalysisandcollateralvaluation
updatesandtypesofacceptablecollateralvaluations?
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OTHER LOAN ISSUES
o TroubledDebtRestructurings(TDR)
Whocanapprove?
ProcesstoidentifyTDR’s
ReportTDR’stomanagementandtheBoard
Disclosureandproperaccountingtreatment
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OTHER LOAN ISSUES
o CreditCards– StillRisky?
Creditcardchargeoffscontinuetodecline
Stabilityoftheaveragecreditcardholderstillunpredictable
Competitiverisksincreasing
Reviewunderwritingapproachesandportfoliomanagement
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OTHER INTERNAL CONTROL ISSUES TO CONSIDER…
o Nomatterhowwellinternalcontrolsaredesignedand
implemented,theycanonlyprovideareasonableassurancethat
objectiveswillbeachieved.Somelimitationsareinherentinall
internalcontrolsystems.Theselimitationinclude:
Judgment– theeffectivenessofcontrolswillbelimitedbydecisionsmade
withhumanjudgment
Breakdowns– evenwelldesignedinternalcontrolscanbreakdown.
Employeessometimesmisunderstandinstructionsorsimplymake
mistakes.Errorsmayalsoresultfromnewtechnologyandthecomplexity
ofcomputerizedinformationsystems.
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OTHER INTERNAL CONTROL ISSUES TO CONSIDER…
o Controllimitationsalsoinclude:
ManagementOverride– highlevelpersonnelmaybeableto
overrideprescribedpoliciesorproceduresforpersonalgainsor
advantages.Thisshouldnotbeconfusedwithmanagement
intervention,whichrepresentsmanagementactionstodepartfrom
prescribedpoliciesandproceduresforlegitimatepurposes.
Collusion – controlsystemcanbecircumventedbyemployee
collusion.Individualsactingcollectivelycanalterfinancialdataor
othermanagementinformationinamannerthatcannotbe
identifiedbycontrolsystems.
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OTHER INTERNAL CONTROL ISSUES TO CONSIDER…
o Whataresomecommonissuesfacedbylending
controlsofCreditUnions?
Notenoughstaff– eachdifferentlendingcyclerequires
separatecontrolsandcreatessegregationofdutiesissues
Tooexpensive – considerthecostsofabreakdown
Trustofemployees– trustworthyemployeesarenotagood
reasontolimittheamountofcontrols
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QUESTIONS
CarrieKennedy,CPAPartnerMossAdamsLLP509‐777‐[email protected]
AnthonyPorter,CPAManagerMossAdamsLLP425‐258‐[email protected]
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QUESTIONS
CarrieKennedy,CPA,PartnerMossAdamsLLP(509)777‐[email protected]
AnthonyPorter,CPA,ManagerMossAdamsLLP(425)258‐[email protected]
