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Expanding credit portfolios: 3 Growing pains

December 9, 2014
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Community banks are expanding their loan portfolios to include more small business loans, according to the most recent Community Bank Performance report by the FDIC. Loans across categories increased, with commercial and industrial loans growing at the fastest rate, roughly 5.3 percent over the 3rd quarter of 2013.

These expansions can come with growing pains, including identifying new customers to whom the bank can make loans, creating more rigorous and objective credit analysis policies and training bank employees on those policies.

Identifying Prospective Clients
For some community banks, the loan portfolio has largely been a reflection of the community it serves – the people and businesses within the portfolio those that power the local economy. In order to grow significantly, however, a bank may choose to expand its reach into businesses and neighborhoods outside the community - their “comfort zone.” These prospects, while not inherently good or bad borrowers, may come with greater information opacity; the bank and its employees may not personally know the people and businesses being considered for loans or lines of credit, which makes it more difficult to understand the character of the borrowers, the health of the economy in that locale or other factors that may not show up on a financial statement.

Once a relationship has been established, it may become easier for the bank to understand any added risk with the borrower. But, while there is no silver bullet for understanding borrowers at the onset, the bank can create risk-mitigation strategies, which will in part include more objective and defensible credit analysis procedures.

Objective Credit Risk Policies
No bank would say they currently use subjective credit risk measures, but if a community bank is expanding into new regions or even new industries, it’s important to have the right procedures in place to ensure the expansion doesn’t also increase risk to the bank.

The following include recommended procedures or policies to review if they are already in place, or create if new to the institution. Note, the list isn’t exhaustive but is meant to highlight some important talking points:

• Identify which source documents are required from the borrower and what time period they should cover (consider both recency and duration)
• Specify what quality of borrower data (audited, compiled, tax returns, etc.) is acceptable
• Determine risk factors to be used within a credit risk model
• Establish the calculations to be performed within spreads and analysis
• Review loan documentation standards for appraisals and other collateral agreements
• Determine appropriate thresholds for risk factors, including specifications for different loan types, industries, etc.
• Explain when a global cash flow analysis is required and how to perform it
• Provide guidance on when to use industry data as benchmarks and where to locate that data
Define risk ratings and impact on decisioning
• Decide pricing information, including relationship profitability data
• Set a minimum review period that encourages continual and regular monitoring and reassessing of risk
• Define covenants and requirements for future submissions of financial data
• Describe acceptable exceptions to documentation policy, underwriting guidelines and mitigants


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Training Bank Employees
Once the bank has reviewed and finalized credit risk policies, the next step to ensuring the bank can grow successfully and with an eye to risk management is to confirm that bank employees are familiar with the policies. This will include loan officers who are building relationships with the prospective borrowers, analysts, admins, senior credit officers and even the Board of Directors.

Through a Sageworks poll, we found that many institutions rely on on-the-job training for tax return analysis – one component of the credit analysis process. While this form of education is successful, it has to be supplemented with formal training. Otherwise, the new loan officer may not, for example, recognize a “red flag” only because they weren’t trained to identify it.

These three growing pains – identifying new borrowers from outside the comfort zone, creating more defensible and objective credit policies and training employees – are likely present in some format within most institutions, and for growing institutions, they will become a larger point of discussion. To manage them, the bank’s executives can prepare and document these credit policies in a way that bolsters growth without slowing the credit department down.

About the Author


Raleigh, N.C.-based Sageworks, a leading provider of lending, credit risk, and portfolio risk software that enables banks and credit unions to efficiently grow and improve the borrower experience, was founded in 1998. Using its platform, Sageworks analyzed over 11.5 million loans, aggregated the corresponding loan data, and created the largest

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