It is the time of year during which budgets are either in the works or have been completed. Typically, when preparing budgets, we project overall growth in our loan portfolios…maybe. Recently we conducted an informal survey, the results of which indicate that loan portfolio growth is still a major target for 2009. But when asked what specific areas in the loan portfolio — or how loan pricing and profitability — will drive that growth, there was little in the way of specifics available. This lack of direction (better put, vision) is a big problem in credit risk management today.
We have to remember that our loan portfolio is the biggest investment vehicle that we have as a financial institution. Yes; it is an investment. We choose not to invest in treasuries or fed funds — and to invest in loan balances instead — because loan balances provide a better return. We have to appropriately assess the risk in each individual credit relationship; but, when it comes down to the basics, when we choose to make a loan, it is our way of investing our depositors’ money and our capital in order to make a profit.
When you compare lending practices of the past to that of well-tested investment techniques, we can see that we have done a poor job with our investment management. Remember the basics of investing, namely: diversification; management of risk; and review of performance. Your loan portfolio should be managed using these same basics. Your loan officers are pitching various investments based on your overall investment goals (credit policy, pricing structure, etc.). Your approval authority is the final review of these investment options. Ongoing monitoring is management of the ongoing risk involved with the loan itself.
What is your vision for your portfolio? What type of diversification model do you have? What type of return is required to appropriately cover risk? Once you have determined your overall vision for the portfolio, you can begin to refine your lending strategy. I’ll comment on that in my next blog entry.
