Manage the Credit Risk in Your Current Loan Portfolio through Policy and Practice


Credit unions can look to TCT Risk Solutions, LLC (TCT) for the management tools and policy assistance needed to effectively manage the risk in their loan portfolios.

Most credit unions have been pretty successful increasing their loan portfolios in the past five years. This growth could be positive (or negative) depending on how the risks in current loan portfolios are managed.

Credit risk in existing loan portfolios needs to be managed through two primary means – in policy and in practice.

Managing Risk through Policy

Managing loan portfolios through policy means making sure the policies are compliant with regulations. It also means making sure policies provide guidance to management and reflect the credit union’s risk-management philosophy. Loan policies have become much more detail and encompassing as a result of regulations and the growing complexity in loan portfolios. At a minimum credit unions should have loan policies addressing:

Loan Concentration Risk Management

Loan concentration policies reflect the limits the credit union will allow in its loan portfolio to be concentrated in for different categories of loans broken out by credit grade, loan type, loan source (participations/purchases, indirect, etc.) and so forth.

Credit Risk Management

Credit risk policies describe the amount of risk the credit union will tolerate in its portfolio as well as how the credit union will identify credit problems early and respond to those problems. Credit Risk Management policies should also describe the tools the credit union will use to manage credit risk and describe how those tools will aid in carrying out policy. Credit Risk Management policy should support other loan policies including Loan Concentration Risk.

Loan Process Management

Loan process policies describe the credit union’s overall lending philosophy, instructions for loan officers, and so forth. Many credit unions have individual loan policies for business loans, consumer loans, collection practices, mortgage loans, etc. Loan process-type policies have grown much more descriptive and complex as a result of regulatory requirements.

Managing Risk through Practice

Managing loan portfolios through practice means actively managing risk through procedures and through the use of effective management tools. TCT provides empirically-derived management tools that been proven to help credit unions manage and control risk in their loan portfolios. These tools include:

Risk Based Loan Pricing (RBL)

This management tool uses statistically derived methods to accurately price loans according to the unique risk each borrower poses based on credit scores. TCT’s RBL is one of few tools that take into account all costs incurred by an individual credit union relative to making loans for each credit grade. TCT’s RBL allows “reaching deeper” into the loan market and assures loans are priced profitably according to operating costs and risk. TCT’s RBL tool is also an effective method for “back-testing” loan pricing methodologies to determine potential risk in existing portfolios.

Credit Migration (CM)

TCT’s Credit Migration tool is one of the most accurate in the market place and provides a CEO the ability to: (1) track and monitor loans individually and collectively (by class and loan type) that are digressing or improving using changes in credit scores for each and every loan; (2) forecast excesses or shortfalls in the Allowance for Loan Loss; (3) assure their boards and regulators that they are using a tool that is: (a) using methods according to latest regulations and GAAP; (b) using a credit union’s unique data and market area data for purpose of establishing environmental factors; (c) validated by one of the leading CPA firms in the nation who specialize in credit union audits. TCT’s CM tool is also effective for determining changes necessary in loan policies and practices sooner than other methods.

Delinquent Loan Tracking Report (DLT)

Few financial institutions track movement of individual past-due loans from one “aging silo” to another. Management benefits from knowing which individual delinquent loans are improving or worsening month by month. This report also provides totals for each aging silo so managers can see if the overall delinquency picture is improving or worsening and why. This report provides a quick picture as to the performance of loan and collection staff and weaknesses in the collection process. TCT’s DLT Report also indicates on a timely basis where changes in policy may be necessary.

Asset Liability Management Modeling (ALM)

TCT’s ALM tool is unique in that it focuses on Earnings (Equity) at Risk (EAR) as opposed to traditional ALM models that employ Net Equity Value (NEV). Students of NEV are aware of the weaknesses this method poses as a process to assess how interest rate changes might impact a credit union. EAR is a far better method for forecasting how earnings/equity will be impacted when interest rates shift in one direction or another. Any significant changes or additions to loan portfolios being considered by credit union managers should first be tested by running simulations using TCT’s ALM tool to determine effects on earnings and Interest Rate Risk.”

TCT Risk Solutions, LLC has been an industry leader for 25 years providing management tools effective in managing risk in loan portfolios. A recent addition to TCT’s services is assistance in drafting policies and auditing existing policies for regulatory compliance.