Getting the most out of portfolio reporting

RMA Journal, The, July-August, 2005 by John Barrickman, Gary D. Stein

Improved reporting can help bankers monitor and manage their portfolios more effectively. Steps to getting the most out of portfolio reporting include knowledge of 1) weaknesses with traditional portfolio reporting; 2) required types of portfolio reports and their content; 3) reporting frequency; and 4) keys to formatting and presenting portfolio reports. These four areas are discussed in this article.

Shareholders, regulators, and industry analysts are increasingly demanding clear, comprehensive, and timely reporting to accurately gauge risks at individual financial institutions. Internally, bank managers and directors need to be educated on how to interpret risk, management reports for new lines of businesses and identify potential issues. While banks tend to generate a great deal of loan portfolio data, they often stumble at organizing, analyzing, and presenting portfolio information--that is, findings, implications, explanations, and recommendations to provide insight and guide decision making.

Importantly, the implications of these shortcomings extend beyond credit quality. Proper perspective and understanding are required to ensure banks are compensated fairly for the risks they take. Furthermore, banks that monitor and understand portfolio risk well are better informed to create competitive advantage, respond to market opportunities, and enhance profitability.

Weaknesses with Traditional Portfolio Reporting

At least four fundamental weaknesses limit the effectiveness of traditional portfolio reporting: a focus on outcomes, a failure to adapt, point-in-time visibility, and using numbers without analysis.

1. A focus on outcomes, not causes. While they are important, summaries of portfolio credit quality that identify delinquencies, nonperforming and nonaccrual loans, criticized/classified assets, and losses reflect the results of lending decisions made three, four, or even five years ago. Current credit-quality measures shed little, if any, light on what to expect in the future and are even weaker quality predictors for banks that have embarked on changes in strategic direction, experienced a change in management or ownership, or entered new markets or lines of business.

2. Failure to adapt. Banks often develop good tracking and reporting systems but fail to augment these capabilities as their lending businesses evolve. This oversight is particularly troublesome as the more advanced forms of lending require unique and often more complex monitoring. For example, banks engaged in leasing should track residuals. Syndicated lenders need to understand the size of their exposure relative to the overall deal and that of other lenders. Residential construction lenders should assess concentrations by property price point and subdivision as well as by market and borrower (i.e., builder). Banks that apply the same reporting processes and structure to all lines of business cannot possibly recognize all relevant risks in their portfolios.

3. Point-in-time visibility. Traditional portfolio reports often provide present-day measures only, with no comparable benchmarks. This limited focus lacks perspective and can lead to "surprises" in portfolio performance. Banks instead should report historical trends and variances with their model portfolios to highlight shifts in credit quality and portfolio composition and any potential changes in the source or magnitude of assumed risk.

4. Numbers without analysis. Banks often report a lot of data but very little information. Most traditional portfolio reports do not include interpretation of results and recommendations for action. Readers of the reports--including executive management and the board of directors--frequently do not have the training to understand raw output in isolation. The failure to provide recommendations can result in a delay or lack of focus in addressing problems and issues.

These weaknesses can mislead management and the board about the risks in the portfolio and the potential for volatility in portfolio credit quality and earnings. Banks should structure their monitoring and reporting practices and capabilities to help them anticipate these issues, determine the potential impact to portfolio credit performance, and provide guidance for problem avoidance and resolution.

Types of Reports

Banks should produce at least five fundamental types of portfolio reports to manage the performance of most lending businesses effectively:

1. Portfolio composition.

2. Portfolio risk.

3. Portfolio profitability.

4. Portfolio credit quality.

5. Loan officer assessments.

More complex lines of business, such as land development and construction and income property lending, present additional, unique risks and require a sixth set of specialized reports.

1. Portfolio composition.

First and foremost, for assessing portfolio composition, banks should report stratifications of the total portfolio by both relationship size and loan size (see Table 1). In addition, banks should produce similar stratification reports for each major line of business. These reports quantify the number of loans/relationships and total balances outstanding within each size stratum. This information is critical to ensuring efficient credit analysis and portfolio monitoring. Banks should consider smaller credits--those below the level at which management would consider a 100% loss material (the bank's "threshold for pain")--as candidates for streamlined underwriting and exception-only monitoring.