Effective MBL Reviews

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Neil Day
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1 2014 CliftonLarsonAllen LLP Effective MBL Reviews Dean Rohne, CPA, CIA

2 Objectives Review key considerations related to a member business loan Discuss key operational best practices of a member business loan department Identify key audit steps in completing an effective MBL audit

3 Business Loan Characteristics Larger loans More sophisticated borrower Cash flow analysis is complex Limited pay-down Complicated collateral liens/guarantees Drawn-out collateral liquidations

4 Business Lending Department Audit Scope Compliance Regulations/Laws Underwriting Procedures Assess member business loan officers and credit analysts Underwriting Risk rating and ALL Appraisals and onsite inspections Legal Title Environmental

5 Business Lending Department Audit Scope Procedures (continued) Loan Servicing Loan Participations Internal Control, Monitoring, and Reporting Member business loan committee Role Responsibilities Documentation Tracking Systems Accuracy of reports Delinquency controls

6 Business Lending Department Audit Scope Internal Control, Monitoring, and Reporting (continued) Specialized loans Trouble debt restructures Safeguarding and monitoring of collateral Financial monitoring Credit File Review Select a sample of loans that include: All loan officers All risk ratings Participations

7 Detail File Review Considerations Provide an overview of the business, borrower, and collateral Identify any related loans Identify whether amount owned and whether it complies with policy and regulations Calculate key ratios of the borrower Consider quality of financial information Debt service coverage ratio Debt to equity Current ratio

8 Detail File Review Considerations (continued) Assess quality of guarantor Calculate net worth Determine amount of liquidity Review credit report Review tax return and qualify adjusted gross income Assess loan collateral Assess risk rating Complete a documentation review

9 Signs of Weakness Defects in the loan and security agreement, loan guarantees, or other documentation Deterioration of collateral Stale information, low level of audit, poor quality No cash flow analysis or review of debt service capability Economic or market conditions that may affect the borrower s ability to meet scheduled payments Declining trends in profitability, liquidity or leverage

10 Business Lending Operations Long time lenders vs. New lenders Onsite staff vs. Outsourced staff Local loans vs. Participation loans

11 Business Lending Operations Assess member business loan committee What is role of the committee? How often do they meet? Are minutes maintained? Do committee members have adequate knowledge and experience?

12 Big Bad Loans When non-performing they are highly visible and painful Second-guessing Easy to identify what should have been done differently before funds were advanced

13 Why Not All Business Loans? Generic business lending policies What type of lending does your staff know? What do you have resources to handle? Do you know how to turn down a loan?

14 Remember your Mission Avoid venture capital situations Examples: Water park/golf course Ethanol Plant The CU is not an industrial development corporation

15 Sophisticated Borrowers Use of separate legal entities to limit recourse Use of legal counsel Negotiation process related to collateral or guarantees

16 Pass-Through Entities Partnerships Limited liability corporations or partnerships Sub S corporations Lending to these requires personal guarantees and /or restrictive covenants to maintain the lender s security interest.

17 Personal Guarantees Personal financial statements are inaccurate Face value versus cash surrender value of life insurance Unsupportable market valuations Seldom prepared by professionals Inadequate disclosures Frequently duplicate value of business

18 Understanding Tax Returns Pass-through entities and distributions Individual schedules C, D, E, F, and Forms 4797 and 4561 (depreciation) Reconciliation of tax reported income to change in net worth on the personal financial statement. Cash flow projections versus historical data

19 Outsourcing Relates to outsourcing underwriting or purchasing loan participations Independence issues and objectivity CU still has responsibility to perform prudent assessment and make the final decision

20 Business Lending is Different Ongoing Monitoring Software and Staffing needs Inspections Credit Union can t be strictly new loan focused Cultural/educational issue for the Board

21 Common Findings Completing and documenting inspections Coordinating risk ratings with reporting Additional monitoring for higher risk loans Limited monitoring of loan participations Not managing concentrations Stale dated financial information Member Guarantor

22 Common Business Lending Mistakes Staying with borrower too long (not recognizing need to get out) Not knowing your member Lack of an established repayment plan No real workout plan for criticized or classified loans Unrealistic expectations on collateral with prior liens Over reliance on personal financial statements without audit or investigation

23 Common Business Lending Mistakes Over reliance on lead lender (participation) Inability to understand cash flows Push over on covenant violations Out of area real estate lending Failing to require material principal reduction before renewing loans Speculative loans for residential construction projects

24 Effective Loan Reviews Segregating credit approval from credit analysis Consider operations beyond the loan files Strength of subsequent loan monitoring Annual reviews Loan committee Consistency of information between documents and reporting

25 Questions? Dean Rohne, CPA, CIA Principal CliftonLarsonAllen LLP

NCUA RLS Jerry Bonk 11/01/2016 3/10/ Lending Hot Topics. Key Lending Issues from an Examiner Perspective

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