How to manage credit risk and avoid the consequences of a re-emerging subprime market.
By Judith Sears
Like the monster in a horror flick, subprime loans appear to be back from the dead. Tim Kluender, president and CEO of $57 million-asset Community Bank Owatonna in Owatonna, Minn., says most community banks don’t partake in subprime lending. However, he says, “Any negative impact on the U.S. economy has the ability to adversely affect community banks and their customers.” Here are some common sense ways to avoid excessive risk.
1. Regularly review your lending standards. Community banks may not be completely insulated from the subprime market due to what Cris deRitis, deputy chief economist for Moody’s Analytics, calls credit score migration. “If you have a 700 credit score today, you’re just below the national average, whereas in 2009, you were well above average,” he says. He encourages banks to regularly review their credit score cutoff threshold to ensure they’re lending to the best borrowers.
is the average FICO credit score in the U.S., the highest average FICO score since 2005
2. Assess your portfolio’s resilience. Review the historical performance of your lending portfolio relative to external benchmarks. How did the loans you booked before or during the last recession perform? “If you’ve loosened your lending standards, you may have additional risk,” deRitis advises.
3. Consider your local economy. If your local economy hasn’t seen as much income growth as the nationwide average, that may dictate maintaining stricter lending standards.
4. Look for ways to “lay off” (or decrease) portfolio risk. Insuring your portfolio with a third party or selling loans are both proven, effective ways of ameliorating portfolio risk.
5. Train your staff. “We have ongoing product education and underwriter training, as we are very active in the residential housing market,” says Neil Grossnicklaus, CEO of $264 million-asset Willamette Valley Bank in Salem, Ore. “Training is important for loan officers but also underwriters and processors due to the complexity of the mortgage process.”
6. Educate your customers. Conduct regular seminars to help borrowers better understand their finances and obligations. Make use of the financial literacy materials from private providers, the FDIC and the OCC. If you put these materials on your website, you could attract millennial customers at the same time.
7. Use technology to confirm creditworthiness. Make sure your bank is up to speed with risk management solutions. It’s now much easier to detect fraud or learn that a borrower already has a second mortgage.
Consumers expect banks to take the lead in controlling risky lending. “We’re supposed to be the experts, so if we say ‘yes,’ that must mean it’s a good loan,” says Sean Kouplen, chairman and CEO of $625 million-asset Regent Bank in Bixby, Okla. “I’m now a disciple that we have to look out for not only making loans that are good for the bank but that are good for the client.”
Judith Sears is a writer in Colorado.