CDFI Loan Policies and Procedures Portfolio Management Series Webinar

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CDFI Loan Policies and ProceduresPortfolio
Management Series Webinar
Developed and delivered by
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Todays Session

• Introductions
• Benefits of a loan policy
• Twelve elements of a good loan policy
• Lending control functions
• Conclusions
• There will be time for questions throughout

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Introductions

• Kristin Faust
• Director of Lending and Network Services at
  Partners for the Common Good
• You, the participants
• Small and large CDFIs
• Loan funds, credit unions, and banks
• Consultants

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Establishing a Loan Policy

• Why do we have loan policies?
• Establishes authority, rules and framework to
  operate and administer the loan portfolio
  effectively
• Controls lending risk
• Ensures the institutions stability and soundness
• If reviewed regularly by the Board will ensure
  that underwriting practices and loan
  documentation are in accord with the Boards
  tolerance for risk

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Establishing a Loan Policy

• Know Your Objective
• Why are you writing loan policies?
• Who is your audience?
• Staff
• Board
• Outside reviewers
• All of the above

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Twelve Elements of a Good Loan Policy

1. Clear mission
2. Specify lending authority
3. Delineate responsibilities for reporting loan
   information
4. Describe origination, underwriting criteria and
   process
5. Documentation for complete application and
   complete credit file
6. State who maintains credit files

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Twelve Elements of a Good Loan Policy

• Collateral guidelines
• Loan rating and loss reserves
• How interest rates and fees are set
• Preferred upper limit for total loans
  outstanding/ concentrations
• Describe trade area
• How to detect, analyze, and work out problem
  loans

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Twelve Elements of a Good Loan Policy

• A clear mission statement for the CDFIs loan
  portfolio

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Example 1

• The Credit and Portfolio Management Policies
  Manual is intended to help staff and board make
  loans that meet the project-related credit needs
  of community development organizations in our
  town while simultaneously meeting our obligations
  to investors for safety, liquidity, and social
  and financial returns.
• The following Credit and Portfolio Management
  Policies are intended to help CDFIs staff and
  Board make loan decisions, and manage and monitor
  the Loan Funds risk related to diversification
  of the CDFIs borrowers, type of project
  financed, and terms of credit extended while
  simultaneously maintaining liquidity and income
  sufficient to meet all of the CDFIs obligations
  to investors.

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Example 2

• CDFI expects and accepts credit risks beyond the
  tolerance of regulated lenders. Management of
  these risks is the primary source of risk
  mitigation. All professional staff are expected
  to be actively involved in managing credit risks.
  
• CDFI will rely on the best judgment of these
  professionals in reviewing and making loan
  decisions. The following criteria will be
  considered by the Loan Committee, Board of
  Directors and staff when reviewing a transaction
  staff is expected to identify the risk of each
  transaction and identify appropriate mitigation
  on a case-by-case basis.

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Example 3

• Guidelines are designed to provide Lenders with a
  description of the types of loans extended, key
  underwriting criteria, and general standards for
  portfolio management.
• These guidelines should be referenced and used in
  conjunction with the CDFI Loan Processing
  Handbook, which more fully details operating
  procedures.

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Considerations/Questions

• Board approved/board review
• Confidentiality
• Rigidity guidelines or policies?
• General quality of loans
• Amount of detail of policies

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Twelve Elements of a Good Loan Policy

• Specification of the lending authority of each
  loan officer and the loan committee including
  the maximum amount and types of loan that each
  person and committee can approve and what
  signatures are required

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Example

• Large Loan Fund/Complex
• Other examples
• All loans go to loan committee
• Staff approves up to small dollar amount

Loan Amount Relationship Exposure Delegated Approval Authority
lt 1,000,000 lt 2,000,000 Chief Credit Officer
gt 1,000,000 lt 2,000,000 CCO CEO
gt 2,000,000 gt2,000,000 Loan Committee
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Considerations

• How many people does it take to approve a loan?
• Do you want one individual to have loan
  authority?
• What is approved by Loan Committee?
• What must go to the Board for approval?

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Twelve Elements of a Good Loan Policy

• Lines of responsibility for making assignments
  and reporting information within the lending
  division

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Example

• Loan applications will be taken by individual
  lenders or assigned by the Chief Lending Officer.
• Entering a written summary of any visit with a
  prospect into the X database is the
  responsibility of the lender.
• Each lender is responsible for recommending an
  upgrade or downgrade of a loan in his/her
  portfolio at the time that pertinent information
  is obtained.

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Considerations/Questions

• Does your CDFI have a shared database where
  lenders and staff can read up on prospective
  borrowers? Existing borrowers?
• Who is responsible for reviewing the loans on a
  regular basis for risk rating changes?
• Do you have a watch list that is regularly
  presented to the Loan Committee?

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Twelve Elements of a Good Loan Policy

• Operating procedures for soliciting, reviewing,
  evaluating, and making decisions on customer loan
  applications

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Example

• Underwriting criteria by loan type
• Real Estate, Business, Single-Family Mortgage,
  Construction Lending, Microfinance, etc.
• Underwriting criteria overarching
• Size and complexity of loan
• Purpose and source of repayment
• Borrowers ability to repay on time
• Borrower eligibility criteria

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Considerations/Questions

• Do you specify different underwriting criteria
  for different types of loans?
• Will you be scoring your loans numerically to
  derive the risk rating?
• Is the scoring grid included in the policies?

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Twelve Elements of a Good Loan Policy

• The required documentation that accompanies each
  loan application and what must be kept in the
  CDFIs credit files

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Example

• Credit files shall be well organized, current and
  include the following information
• Correspondence with Borrower
• Borrower organizational documents
• Loan documents
• Insurance documents
• Disbursement records
• Risk rating records
• Borrower, guarantor and/or project financial
  information
• Project pro formas
• Project budgets
• Loan application
• Collateral information and other relevant
  documentation used in making the credit decision
  or reviewed prior to loan closing

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Considerations

• What filing system will you employ?
• Credit files, collateral files, monitoring files,
  desk files do you need them all?
• What goes in each?
• Collateral files need to be in fireproof
  container
• Hard copy files or electronic files?

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Twelve Elements of a Good Loan Policy

• Lines of authority within the CDFI detailing who
  is responsible for maintaining and reviewing the
  credit files

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Example

• The Lender shall be responsible for creating and
  maintaining the credit file for each loan that is
  approved and closed.
• Annually, the Chief Credit Officer shall conduct
  a review of the credit files to ensure
  completeness

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Considerations/Questions

• How to increase compliance with this requirement?
  
• Clean-Up Day

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Twelve Elements of a Good Loan Policy

• Guidelines for taking, evaluating, and perfecting
  loan collateral

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Example

• Loan Security
• General policy of loan security An
  unconditional repayment guarantee shall be
  required for all loans. In addition to a
  guarantee, the CDFIs policy shall be to require
  security for all loans.

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Example

• Collateral valuation standards
• In the case of real property, the Fund will
  require an appraisal document. Although the Fund
  recognizes that a fully documented, current, MAI
  appraisal is beyond the financial capacity of
  most of the Funds borrowers, an appraisal
  document acceptable to the Fund shall be
  required. An appraisal document includes one of
  the following
• A letter of appraisal updating a previously
  completed fully documented appraisal
• A letter of opinion of value prepared by a
  licensed real estate broker provided the value is
  substantiated with comparable sales and other
  documentation vs.
• A form appraisal prepared by a licensed real
  estate appraiser.

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Example

• LTV not to exceed x without Board Approval
• For loans up to and including 100,000, a staff
  prepared collateral valuation based on current
  market data will be acceptable subject to
  approval from the appropriate levels of loan
  authorizations.
• Unsecured loans
• Unsecured loans should be considered when a
  strong and creditworthy borrower makes such a
  request

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Considerations

• Do you have consistency in applying
  collateral/security standards?
• Where can you as CDFI show flexibility?
• What is an exception?
• Who can approve an exception?

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Twelve Elements of a Good Loan Policy

• Establish a risk rating system and loan loss
  reserves

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A Risk Rating System

• A risk rating system allows the CDFI to classify
  its loan portfolio by different levels of risk
• Risk is determined by criteria associated with
  the loan such as payment history, previous
  history of borrowing with the fund, LTV, cash
  flow and external factors among others.
• CDFI may start with a system that mirrors another
  CDFI but it should be refined and revised as time
  goes on and the CDFI gains more experience with
  its particular type of lending and market.
• Most CDFIs will link risk ratings to established
  Loan Loss Reserve amounts

CDFI Fund Capacity Building Initiative

Loan
Policies and Procedures
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Example

1. Moderate Risk - Two or more of the following
   characteristics loan has sufficient collateral
   and cash flow and presents no new risks
   collateral, cash flow, and credit exceed
   requirements (LTV 70 90)
2. Average Risk Collateral, cash flow and credit
   cover loan (LTV 90)
3. Substantial Risk Tight collateral coverage or
   cash flow of debt service is tight (less than
   1.05)
4. High Risk Payments 30 days past due, weak
   financial condition, uncooperative borrowers,
   non-existent financial reports, external events
   with serious negative impacts, possible workout
5. Work-Out Payments 60 days past due, value of
   collateral or guarantee is less than loan

CDFI Fund Capacity Building Initiative

Loan
Policies and Procedures
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Linking Risk Rating to Reserves
Risk Rating Reserve
1 3
2 5
3 10
4 20
5 50 or more determined per loan
CDFI Fund Capacity Building Initiative

Loan
Policies and Procedures
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Considerations/Questions

• How often do you review risk ratings?
• Whose responsibility is it?
• Is the risk rating linked to the loan reserve?
• If not, how often is the reserve calculated?

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Twelve Elements of a Good Loan Policy

• Guidelines for rates and terms on loans

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Examples

• Interest rates will be established and reviewed
  at each Loan Committee meeting by the Loan
  Committee members. The CFO shall be responsible
  for submitting sufficient information before each
  meeting including but not limited to 1) Other
  lender rates, 2) Cost of funds, 3) Budgeted
  interest rate spread.
• The CEO shall establish interest rates and fees.

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Considerations

• Document how rates and fees are set and other
  pricing considerations are set.
• Is there a regular review of fees, rates and
  terms?

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Twelve Elements of a Good Loan Policy

• A statement of the preferred upper limit for
  total loans outstanding, portfolio mix and
  concentrations

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Example

• In order to reduce risks in its portfolio
  resulting from various potential concentrations
  of loan volume, CDFI establishes the following
  limits as a percentage of lending capital
• 15 to any one borrower
• 25 to one type of business
• 33 in loans secured by vacant land
• 35 in unsecured loans
• 25 in one geographic area

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Considerations/Questions

• How do you define lending capital?
• Borrowed capital
• Borrowed capital equity capital
• Loans outstanding
• Consider clause such as CDFI may reconsider
  these limits from time to time due to product
  performance, or growth in capital available for
  lending, or other pertinent factors.

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12 Elements of a Good Loan Policy

• A description of the CDFIs principal trade
  area from which most loans should come.

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Examples

• For all loans, the borrower must live or be
  interested in purchasing in X, Y or Z counties in
  Our State.
• Loan requests are generated on a national basis
  through local offices and affiliates.

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Considerations

• How will you allow exceptions?
• Will you follow an existing customer outside your
  geographic area?
• How will you track and report exceptions?

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Twelve Elements of a Good Loan Policy

• A discussion of the preferred procedures for
  detecting, analyzing and working out problem loan
  situations

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Example

• If by the 90th day no payment has been received,
  the Loan Committee will examine the situation,
  based upon a detailed account of the borrowers
  operational information and a review of the
  collateral. The Loan Committee will develop a
  strategy for further action, including
• Loan restructuring
• Strategy to liquidate the collateral
• Notice of default and the intention to foreclose
• A further forbearance of action based upon
  certainty of repayment and confidence of
  operations
• Sending the loan to a collection agency (not
  common)

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Considerations

• Be specific
• Who is responsible for collections?
• Do you have a clear definition for extensions for
  Restructured Loans?
• When do you start foreclosure?
• When do you charge off delinquent loans?
• Have you built in the flexibility you might need?
• Who has authority to make the decision about next
  steps?
• What reports does the Board see regularly to help
  them stay current with problem loans?

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Lending Control Functions

• Audit Functions
• Loan Review
• Portfolio Review

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Lending Control Functions

• Audit Functions
• Does your auditor review credit files?
• What do they look for?
• Do you ask them for their results?

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Lending Control Functions

• Loan Review
• Assesses individual loans including repayment
  risks
• Determines compliance with loan policies
• Identifies lapses in documentation
• Evaluates the risk rating

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Lending Control Functions

• Portfolio Review
• Aggregates data on portfolio
• Measures against defined portfolio limits
• Helps identify risk at a more macro level

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Considerations

• Determine frequency
• Determine who does the work
• Consider impact on staff/workflow

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Sample Loan Policy Table of Contents

1. Introduction
2. Mission Statement
3. Scope of Services
4. Loan Limits
5. Interest Rates and Fees
6. Loan Approval Authority
7. Loan Origination Standards
8. Modifications and Extensions
9. Credit and Security Standards
10. Risk Rating Classifications
11. Underwriting Standards

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Sample Loan Policy Table of Contents

• 12. Underwriting Standards for For-Profit
  Borrowers
• 13. Construction Loan Underwriting and Management
• 14. Borrower Financial Reporting
• 15. Real Estate Appraisals
• 16. Environmental and Hazardous Substance Risks
• Attachments
• Risk rating by product type
• Guidelines for completing the credit request memo
• Sample appraisal engagement letter
• Personal financial statement forms
• Special loan program requirements and loan terms

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Sample 2 Table of Contents

1. Mission
2. Introduction
3. General Provisions
4. Loan Committee Special Program 1
5. Loan Committee Special Program 2
6. Standard Lending purpose, eligibility, terms
   security, closing costs, environmental risk,
   escrows, commitment process, denial of
   applications,
7. Lending Criteria and Procedures
8. Loan Servicing Collections
9. Exception of Lending Policy

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Concluding Thoughts

• Even revisions can take a long time
• Give up on perfection aim for prudent, clear
  and representative of what you are doing (as long
  as what you are doing is sound lending!)
• Consider your own organizations dynamics
• Loan policies work together like underwriting
• Policies are only as good as your practices

CDFI Fund Capacity Building Initiative

Loan
Policies and Procedures
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Wrap-Up

• This presentation is the first in a series of
  four webinars to be held over the next few
  months. The others are
• Raising Debt Equity from External Sources
• Risk-Assessing Your Own Organization
• Managing Troubled Assets
• Register at
• http//www.carseyinstitute.unh.edu/CDFI-webinars.h
  tml
• For more information about the CDFI Capacity
  Building Initiative, visit
• http//www.cdfifund.gov/

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Wrap-Up

• Sample documents, etc. will be available as part
  of a Resource Bank on the CDFI Funds Capacity
  Building Initiative webpage later this summer.
  Please see http//www.cdfifund.gov/cbi to view
  the Resource Bank and other helpful information
  on the Capacity Building Initiative.
• As part of the Capacity Building Initiative, free
  TA is available for CDFIs. To sign up, email
• jack_at_nemarketresearch.com or
  ehangen_at_i2community.org
• If you have not taken the survey, please do so at
  the following link
• http//www.unh.edu/survey-center/cdfi.html

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CDFI Loan Policies and Procedures

• Questions? You can email me at faustk_at_pcgloanfund.
  org
• Thanks for being with us today!