Loathe the Annual Review? Turn the dreaded exercise into an opportunity to mitigate risk and strengthen borrower relationships
Commercial Banks should optimize the lengthy annual review process by categorizing and prioritizing borrowersOakNorth
September 7, 2023
We often hear from relationship managers (RMs) that the part of the job they dread most is the annual review process.
The amount of time RMs spend conducting annual reviews on their commercial portfolio depends on several factors, but what we hear across the board is that it's too time-consuming and often provides little value. RMs typically handle a portfolio of dozens if not hundreds of borrowers, and the complexity of each loan in the portfolio can significantly impact the time required for annual reviews. More complex loans might involve intricate financials, multiple parties, and various collateral types, requiring a more in-depth analysis.
The review process might be more streamlined if an RM has a strong rapport with the borrower and is familiar with their financial situation. Equally, if they have up-to-date financial data from the borrower and this data is readily available and organized, it will make things quicker and easier. While some commercial banks have automated systems that facilitate this kind of data collection and analysis, most rely on more manual processes which take longer. Depending on the regulatory environment and the risk profile of the loans, more thorough reviews might be required, leading to longer review times. For example, during times of economic uncertainty such as that we’re in currently, regulators may require banks to carry out a more in-depth assessment.
A typical annual review process starts with the gathering of financial data from the borrower, including updated financial statements, tax returns, cash flow projections, and any other information to help determine the borrower's financial health and ability to meet their debt obligations. RMs also review the loan documentation, collateral records, and any existing risk assessments or reports from previous reviews. If the loans are secured by collateral, RMs evaluate the current value and quality of the collateral, which could involve appraisals, inspections, or other valuation methods – all of which typically take weeks to arrange. RMs will then assess any changes in the borrower's risk profile since the last review, including evaluating factors such as business performance, cash flow stability, industry volatility, and potential exposure to new risks.
If there have been significant changes in the borrower's financial situation or risk profile, the review might lead to discussions about loan renewal, extension, or restructuring. Based on the review findings, the relationship manager, in collaboration with credit analysts and other relevant departments, makes a recommendation regarding the borrower's credit status. This might involve revising financial projections, adjusting collateral arrangements, or addressing any concerns identified during the review.
Given the above, it’s unsurprising that RMs loathe annual reviews so much, and why it’s become a check-box regulatory exercise, and can often end up hindering relationships with customers rather than helping strengthen them.
We developed ON Monitoring precisely to address these challenges – using signals based on historical trends, point-in-time performance, performance relative to peer benchmarks (based on industry), and forward-looking/forecast performance, we help commercial banks identify and categorize risky and healthy borrowers.
Banks can then use these to rank borrowers for priority review – for example, a borrower who is outperforming industry benchmarks (i.e. outperforms internal peers, and scores high relative to market aggregates), has no historical anomalies, and is part of an industry projected to grow, can be prioritized for low-intensity review. Where a bank has a lower-than-normal exposure to a low-risk borrower, the RM can start to look at where there may be opportunities to lend more. It also identifies segments of the loan book where borrowers have too much leverage compared to peers, so the bank can take proactive steps to mitigate this risk.
This approach can reduce the time spent conducting annual reviews by up to 33% as RMs can review the right borrower at the right time with the right intensity. This improves efficiency and reduces the credit risk cost as the bank needs to hold lower reserves and can therefore use that capital to grow their loan book.
The annual review process is sucking up time and efficiency from commercial banks and their RMs. Borrower review prioritization puts the power back in RM's hands, creating a better experience for the customer, and ensuring the right amount of time is spent on each borrower.