Before it switched from manually reviewing its loan portfolio to analyzing it using loan monitoring software, Old Point National Bank had no centralized way to examine loans and spot potential problems.
"We would physically have to walk around with hundreds of pieces of paper, and I wasn't able to pull everything together to get a unified view of the risk in the portfolio," says Sharon Davidson, the senior loan review officer at the $912 million-asset bank in Hampton, Va. "We spent more time organizing the pages than really focusing on risk, and communicating that risk to management."
In 2006, Old Point invested in loan monitoring software from DiCom Software in Orlando, which collects and analyzes information about its borrowers as well as the economies of its markets. Before the software was installed, each banker in charge of reviewing loans would rate them in a slightly different manner. "The reviews were not wrong- it's just that people would have applied different spins," she says.
Now Davidson can retrieve the bankers' reviews online with DiCom's software and better compare apples to apples. "Most importantly, we know where our problems are, and there are no surprises," she says.
A growing number of community banks are using loan monitoring software to gain a better understanding of the quality of their loans-and the quality of their overall portfolio. After the financial crisis wreaked havoc on asset quality-particularly from heavy residential construction or commercial real estate loan concentrations-regulators began demanding that banks put in place systems that could catch problems before they escalate.
According to a March report by TowerGroup, the Office of the Comptroller of the Currency requires banks to oversee the quality of their risk management by monitoring and enforcing loan agreements and covenants, both financial and nonfinancial.
For commercial real estate loan portfolios, the Federal Deposit Insurance Corp. suggests that banks monitor the loans using management information systems, along with updated borrower financial information and analysis. Moreover, the Sarbanes-Oxley Act mandates the consistent application of credit and portfolio monitoring and management processes.
As a result of these requirements, spending on commercial loan monitoring systems is expected to grow at a 4.4 percent compound annual rate, from $156 million in 2010 to $170 million in 2012, TowerGroup estimates.
Susan Feinberg, an analyst at TowerGroup, likens loan monitoring software to early warning systems for tsunamis that recently have been installed by cities at risk for these natural disasters. "If you only check to see if you have a problem every six months or once a year, you could have drowned already," she says.
Yet because loan monitoring software automates the process, bank executives can review portfolios much more frequently. "You're able to get early warnings, and you then can work with the clients before you get to the point that you have to write things off," she says.
Pat Carey, a vice president and senior lender at First National Bank of Sycamore in Ohio, says that with monitoring software from Sageworks Inc., he can tell if a customer is making payments later and later each month or not submitting year-end financial statements on a timely basis. Carey says these are "red flags" that would indicate that cash flow is tight and that a customer is in danger of falling behind on loan payments.
By addressing these problems early on, Carey says he can work with the customer on possible workout arrangements, properly risk-rate the loan and, if necessary, account for the loan in the bank's loan-loss reserves.
Doug Latare, an executive vice president of DiCom, says his company's loan monitoring software enables bankers to aggregate information from various systems they likely already manage: core processing or "financial-spreading" software that stores customers' financial statement information; loan accounting data; and economic data on individual markets or industries that the bank serves. For example, the software enables a banker to request a review of all customers with a debt service coverage ratio below 1.2 as well as a loan-to-value ratio exceeding 80 percent, Latare says. The banker can narrow that search further to review customers with those ratios within a particular industry, or in a specific market, or by loan type.
DiCom, like other vendors, offers portfolio stress testing and concentration analysis capabilities. "You can do what-if analysis-figuring out the worst-case scenario or multiple scenarios to see what the impact would be on the portfolio," Latare says. "Not only are regulators asking for this, but the investment community is also asking for it-and the current economic environment demands that banks be more predictive with their portfolios."
Another advantage to loan monitoring software is that it acts as an effective "tickler" system to identify when borrowers need to submit business and personal income statements as well as tax and insurance payment documentation, says Drew White, Sageworks' chief financial officer. "If you have 400 loans, it gets to be a challenge to keep all of these documents straight," White says. "Moreover, if a loan officer only gets half of the documents, they'll have to contact the borrowers again, and so it becomes a fairly serious organizational task."
First National's Carey says his managers previously had relied on a rudimentary tickler system from its core processing software. Yet the software would generate a postcard-size notice that the customer either didn't take seriously or didn't see because it was so small. With Sageworks' software, First National has an effective system for automatically generating customized letters explaining why it needs the information. It also can tailor language in the letters if customers fail to respond. "If we don't receive the documents after a certain time, we can increase the severity of the wording of the letter so that it gets across to the customer that the documentation is critical," Carey says.
Sean Lee, the chief executive of Bankinfra Technology Inc. in Los Angeles, says tickler systems also can take into account qualitative reports from loan officers, helping banks make consistent decisions on loans according to centralized policies and procedures. "Some banks have different sets of loan portfolios for loan officers and they may need to collect all necessary information manually to follow up individual prospects and problem loans without a business intelligence system," Lee says.
Commerce Bancshares Inc. in Kansas City, Mo., was one of the first companies to invest in loan monitoring software earlier this decade. Kent Kirby, a senior vice president and loan review officer, says the software is easy to use. "You really don't have to be a statistician or mathematician-a normal banker can use it," Kirby says.
Perhaps the most critical function performed by the software is identifying exactly which types of loans-and how many of them-could one day become nonperforming. "That is actually the hardest part-figuring out whether you have a big enough problem to worry about," Kirby says. "Then you've got to think strategically about whether to get more cash flow, how to get the loan worked out or whether to foreclose on the building."
Still Kirby emphasizes that it's not wise to rely solely on loan monitoring software to evaluate credit quality. "Software is just a tool-you still have to use your brain," Kirby says.