The loan committee: up close & personal

Beverly J. Foster

Entrepreneurs recognize them as a necessary evil, while banks may succeed or fail by their decisions. The need for fast, efficient response while retaining sound judgment has led many banks to employ automation, move to a signature system, and in other ways transform the traditional loan committee, where individuals representing various areas of the bank come together to talk over loan requests. Here is what's been happening at six RMA member institutions.

U.S. banking turns 220 this year. Robert Morris--then Superintendent of Finance under the Articles of Confederation in the fledgling nation--in 1784 proposed establishing the Bank of North America as America's first commercial bank. More than 75 years later, in 1863, the National Bank Act allowed banks to be established through means other than legislative act. But ever since, loan policies and loan committees have been developing and evolving. Institutions' methods of commercial loan decisioning run the gamut from a few people meeting periodically to discuss repayment history, collateral, character of the principals, purpose of the loan, and so forth, to the e-mail "virtual loan committee," (1) to the totally automated or outsourced decision process.

The Editorial Advisory Board of The RMA Journal had a few questions about loan committees at today's small institutions, and John Anderson, David Dohmen, George Bruns, Carolyn O'Leary, Jack Barrett, and Mikkalya Murray responded by e-mail to nine questions about their institutions' loan committees.

Growth, regulatory changes, increased problem loans, mergers, technology, and more contribute to a bank's decision to make changes in its loan committee structure and process. As Jack Barrett, president and CEO of First Citrus Bank of Tampa, Florida, says in his interview in this issue (pages 8-14), his bank has grown significantly, and rudimentary, informal methods that may have sufficed for a $15 million bank had to develop further. "As we've grown to more than $120 million, underwriting and approval processes have deepened to include greater detail and more comprehensive analysis," he says. First Citrus Bank now has a lending template, and the committee itself has added experts in a greater variety of professions.

Following its regulator's recommendation, Equitable Federal Savings Bank of Grand Island, Nebraska, established within the past five years a loan committee to review and approve agricultural and commercial loan credits, as well as mortgage and consumer as needed. As the bank developed its commercial department, it saw the need for a more formal and higher-quality underwriting process to reduce the bank's risk. "The loan committee also reviews risk ratings, delinquent loan reports, and other loan business as necessary," says David Dohmen, SVP and chief lending officer for the bank. As a checks-and-balance measure, Equitable's executive board committee reviews and ratifies the loan committee's operations.

With the introduction of a new credit policy manual in 2000, Banknorth's loan committee, purview, written policy, organization and membership, authority, and responsibilities have changed as well. "We start with signing authorities for smaller exposures, and we have four types of committees for larger exposures," says George Bruns, SVP and senior corporate credit administration manager. "There is a management loan committee, senior credit committee, specialty loan committee, and board risk committee. Each committee has defined responsibilities by aggregate exposure, risk rating, type of business, and specific credit conditions. Generally, as credits become larger, they are presented successively to higher-level committees."

Despite these changes, neither Banknorth nor First Citrus has changed from a loan committee to a signature system, while other banks are doing so, at least to some degree. Annapolis Banking & Trust Company (AB&T) has had "no material change" in the past five years, says Carolyn O'Leary, EVP, although the bank's credit policy provides for a signature system under certain conditions, with the approved loans then reported to and reviewed by the loan committee.

The signature system is employed as well at technology-savvy Harleysville National Bank for smaller, less complex credits, reports Mikkalya Murray, EVP/CCO. Harleysville's loan committee rarely comes together to meet face-to-face. Instead, "the committee sees fewer credits than do individual and matrix authorities as the bank has grown," she says. "We still require three voting members for a quorum, and we meet electronically by e-mail. We retain fairly detailed minutes and documentation of the materials presented. All files are electronic, so they can be shared with the board of directors, our auditors, and the OCC."

The loan committee at Dollar Bank has not seen that much change either, says John Anderson, SVP for Corporate Banking, although his name for it is credit committee. "And we have very little signature authority," he says, "although three members of the credit committee can approve certain loans without going through the committee process." (Dollar Bank may be one of the very few banks to share information on loan committees and other bank functions with its current and prospective customers through its Web site--see www.dollarbankbusiness center.com/resources/LoanCommi ttee.html.)

Is Quicker Really Quicker?

Is direct sign-off really faster? Murray has a very quick answer to this one: "Our electronic response time is two hours or less," she says. Some banks may be marketing themselves as quicker on the basis of a direct sign-off approach, but Murray says this isn't true "if they are still doing the processing manually." Jack Barrett believes direct sign-off can be faster if used appropriately for "no-brainer" loans.

"We hear about signature authority all the time," says Anderson. "However, we always seem to be quicker than our competitors when getting back to the customers. I think that the larger bank officers tend to have too much on their plates to even get the proper signatures quickly. We are always quick to respond to the customer with a working proposal that cuts to the chase. The committee process follows if terms are acceptable."

"Our loan officers have established lending limits, but when a credit exceeds that limit, they still can negotiate terms and present options to the customer within a reasonable length of time," says Dohmen. "Our loan officers have sufficient knowledge to allow the loan committee to feel comfortable with their credit decisions."

"Signature systems can be quicker, but they also present problems," says Bruns, citing as examples different presentations to different people, "button-holing" for quick approvals, and so forth. "We believe that exposing credits to the best credit people in the bank has served us well through some difficult economic times," he says. "In addition, for our largest credits, we continue to feel that we benefit from the questions asked by our board members."

All the banks have provisions for faster responses as necessary. Equitable's CEO and chief lending officer are available to assist with credit decisions if the loan committee cannot meet promptly. AB&T's loan committee can be convened "at very short notice when circumstances require," says O'Leary. Banknorth and First Citrus also can call special, or ad hoc, committee meetings as necessary, and Banknorth has a provision for "emergency" signing authorities. Murray says that the SLC chair at Harleysville holds the lending authority of the committee, if needed, to accommodate a customer. Bruns sums it up well when he says, "Banks that believe in the loan committee system believe in it as passionately as others believe in the signature system."

Pressure to Change

A natural regulatory reaction to greater losses during a recession would be to put on the pressure for more stringent practices within the loan committee. Yet none of the banks surveyed experienced this. Although Equitable was prompted by its regulators to establish a loan committee in the first place, it has not experienced any further pressure. Anderson says that Dollar Bank is usually complimented on the written presentations for its committees and the controls implemented in the approval process. Jack Barrett agrees, saying that at First Citrus, "This is the area where [regulators] primarily are the most complimentary."

Involving the Board in Loan Decisions

Size of the institution is likely to affect the loan level at which board involvement seems appropriate. First Citrus involves the board at the $2.5 million level. At Equitable, the executive committee of the board ratifies all loan committee decisions. "If the credit request exceeds the loan committee approval limits, the executive committee will underwrite the loan based on the loan committee's recommendation," says Dohmen. "All loans approved are reported to the board of directors by the chief lending officer at the monthly board meeting."

Dollar Bank's asset committee, which includes several members of the board, meets on a regularly scheduled basis to approve or ratify loans "over a certain amount," says Anderson. Meanwhile, AB&T involves its board "at a relatively low level," says O'Leary. "Our legal lending limit is approximately $7.2 million; the internal lending limit--or policy limit--is $5 million, and loans or relationships with total exposure greater than $750,000 must also be approved by an executive committee of the board," she explains.

Banknorth's board risk committee sees the majority of credits at the $15 million level--higher for very strong credits and lower for criticized and classified assets. The board risk committee, an integral part of the bank's enterprise risk management process, has oversight over all of the regulatory risk categories. Harleysville involves the board only from a policy and oversight perspective.

The Merger Factor

Mergers have not had an impact on how four of the six institutions' loan committees operate (one bank has not had any mergers). Since its acquisition on a Cleveland, Ohio, operation, Dollar Bank has used teleconferencing for its loan committee presentations.

Asked whether growth might lead a bank to move its loan committee operation under the larger risk management umbrella, Bruns says, "We would not, and do not believe our regulators would favor absorbing the loan committee into risk management. We believe that the approval process should be driven by the line, with a majority of line membership, but with risk management having a strong voice." Harleysville believes professional lenders and credit officers make the best credit decisions, says Murray. "We believe risk management needs to be independent, to overlook the process but not become a part of it."

Barrett sees that having the loan committee function housed within risk management could help illuminate risk consequences of lending-activity response to the bank's strategic objectives. And O'Leary believes that if the loan committee remains intact but becomes part of a larger group, "the agendas could become more complex and far-reaching, which might adversely affect the time spent in loan committee (more, rather than less, time) and cause a bank to reconsider who attends such meetings. On the other hand, the discussion of a broader view of risk than simple credit-and-lending risk could be educational for attendees and valuable in terms of shared knowledge."

The Loan Committee: Strengths, Weaknesses, and Abuse of Power

"The greatest weakness is still the 'risky shift' syndrome," (2) says Murray. "The greatest strength is the combination of varying viewpoints to make the best possible decision."

Meanwhile, Barrett sees possible problems with timing and decision turnaround, but agrees that the broadened perspective and feedback are a strength of the loan committee. Bruns elaborates, saying, "The committee provides a forum where the most experienced credit officers hear a consistent presentation and are able to produce a 'consensus,' which is the bank's view of the credit. Lower-level committees, in particular, provide opportunities for junior officers and analysts to learn good structuring and analytic techniques and to become attuned to the culture of the organization. Committees also are excellent communication forums as underwriting appetites change over time."

The chair of the loan committee often is a directing force. Anderson's experience with three banks is that the committee chair has most of the power, "subliminally or otherwise." Murray acknowledges that, as chair herself, "it can be difficult to refrain from pushing your opinion on others. I try to make extra efforts and not circumvent the authority of the group."

O'Leary, who has been in banking for 25 years, says she has never observed any abuse of power by the committee or its chair. "The chairs I have observed and worked for took their responsibilities seriously and believed that the loan committee had a very strong educational purpose," she says. "I actually think the potential for an abuse of power is higher in a direct sign-off environment."

Dohmen is convinced that the loan committee affords Equitable a much better handle on managing the risks in its loan portfolio. He says that while the chief lending officer is the chair of the loan committee, the president/CEO is a member of the loan committee, which, he adds, "removes any abuse of power by the chair or other committee members. All decisions are 'committee' decisions. This process has given us more input and better communication within the loan department."

Next Steps to Best Practices

Banknorth has made "considerable improvements in the quality of our written loan analyses in recent years," says Bruns. "It's expected that write-ups will have been read and are understood." He further believes that oral presentations to credit committees should focus on key risks and mitigants as well as new information as it becomes available. Loan committees should strive to be egalitarian forums, where "any voting member feels free to contribute."

Banknorth has a rotating membership in some of its lower-level committees, which Bruns considers to be an excellent developmental opportunity. Bruns has additional advice for institutions seeking best practices in its loan committees. "Analysts should be encouraged to participate in the discussions. Also, committees can and should improve structuring, but should not be the principal means by which loan structuring takes place in the bank. Such a practice would produce weak lenders, who are unable to represent the bank well to its customers."

"I've often wondered whether or not a true 'vote' should be taken on loan proposals at the committee level," says Anderson. "But I've concluded that having each member vote would result in many loans not being approved. It's always safe and easy to vote no. In the end, the head of the committee has to weigh the positives of the loan proposal as presented by the lending officer against the negatives (if any) expressed by the committee members."

Dohmen says that Equitable will continue to seek improvement in streamlining the loan committee process as well as continue to improve loan quality, making adjustments as needed to minimize the bank's risk. Murray follows suit, with technology on the front burner. "We want to continue to grow earning assets while balancing the credit risk and approval fulfillment processes. In other words, we want to make safe and sound loans!" And Barrett sees the need to focus more on enhanced training with loan committee members and will make formalization of training a strategic target in coming months.

Reports of Its Death Are Premature

So it appears that the loan committee is alive and well in the community bank. There may be technological enhancements to help streamline the process, as well as other improvements to the committee structure and process as institutions grow and become more complex. However, the value of feedback and the learning experience is indisputable. And the loan committee, in good times and bad, has proven itself able to ensure the safety and soundness of community banks throughout the U.S. and the world.

Notes

(1) OnePoint, Baker Hill's 32 bit, consolidated database, is designed with four integrated modules for customer relationship management: Enterprise Sales Pipeline Management, Financial Statement Analysis, Collateral & Exception Tracking, and Relationship Pricing & Profitability. The "virtual loan committee" works by allowing loan committee members, located in a number of cities throughout the state, to review loans via e-mail without having an actual meeting.

(2) Risky shift syndrome is when decisions are made jointly, such as in a committee environment. There exists the risk that an individual lender will "shift" the responsibility for the decision to the group, thus negating his or her personal accountability for the loan decision. If the deal goes bad, it was "the committee's fault."

Beverly Foster is editor of The RMA Journal.

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