Be a loan detective

A loan quality assurance program solves lending inefficiencies

Have you ever watched a television crime drama where the baffled detectives have a victim but no visible clues to the crime? Where do they turn for answers? The friendly neighborhood forensic pathologist, of course. This modern-day Quincy uses a vast arsenal of technology, combined with scientific method, to conduct an autopsy that unlocks the mystery and identifies the bad guy.

What does this have to do with my credit union? Good question. Just like an autopsy on a person attempts to identify the cause of death, a loan autopsy attempts to zero in on what caused a loan's success or failure.

The loan autopsy is the central element of a loan quality assurance program. This program is designed to review loans to determine whether staff follow proper procedures and to confirm that the credit union's lending policies are achieving their desired results. Loans are a credit union's most valuable asset, so it's essential to protect the loan portfolio's overall quality and productivity. Apple Federal Credit Union, Fairfax, Va., has found a loan quality assurance program a helpful tool for that process.

The first step is to assemble the loan review committee. It's best to have people representing several different functional areas within the credit union. At a minimum, have a management representative from the lending, branch operations, accounting, and collections departments. These team members have a unique perspective on the lending process and are able to spot issues relevant to their areas of expertise.

Next, the committee needs a framework to review the loans. The most important reference materials are your lending guidelines and your operations and procedures manual (or other relevant set of credit union policies and procedures). Pay special attention to those parts of the guidelines and policies that directly relate to the member's qualification for the loan and the loan setup and disbursement. Each committee member should be familiar with these materials before they review the loans.

Finally, we're ready to select and review the loans. Review loans quarterly to allow for good loan monitoring without overloading the committee. Meet during the middle of every third month so you don't interfere with month-end obligations. To get a sufficient cross-sampling of loans, randomly select five approved, denied, delinquent (at least 60 days), and charged-off loans.

Pull the following documents for each loan selected: membership application, loan application and supporting documents, computer screen prints showing loan setup and disbursement, credit report from the application date, credit committee notes, loan disbursement check, subsequent credit reports, payment history, and collection notes. Not all of these documents will apply to each loan.

We developed a simple checklist for each loan. It allows us to track issues with particular loans, provides a place to record observations, and ensures uniformity in the review process.

When reviewing loans, the committee must answer several key questions:

* Was the loan documentation properly prepared and preserved? Determine if staff followed all internal guidelines and procedures when completing the documents. Check for correct member information, proper security interest, credit score, signatures, dates, and endorsements. If any documents are missing, determine if there are problems with document creation or retention.

* Were the credit union's lending guidelines followed? The loan application, supporting documents, and credit reports provide a snapshot of the member's financial condition at the time of the loan request. Compare that condition to the guidelines in effect at the time the loan was made. If the loan fell outside of the guidelines, consider whether it was approved or denied improperly. Look at staff's notes for clues. If the loan was properly approved but later became delinquent, review subsequent credit reports and collection notes to determine what happened and if it could have been avoided.

* Was the loan set up and disbursed properly? A review of the computer system will reveal if the loan was properly created and entered in the system. Pay special attention to the due date, interest rate, payment amount, and payroll/payment setup to confirm the correct information was transferred to data processing.

* If the loan went to collections, was it handled effectively? The collections department is a crucial element of the lending process. Its actions can either rehabilitate a delinquent loan or push a struggling member over the edge and into bankruptcy. Confirm that the member was contacted soon after the account became delinquent and that the collector provided proper counseling. If the member ultimately files for bankruptcy, it's important to confirm that proper procedures were followed to notate the account and restrict collection activity.

After the committee completes its review, the results will create an excellent opportunity to revise lending guidelines, policies, and procedures as needed to address shortcomings. It also may identify staff training needs or help in amending instructions provided to front-line and back-office personnel. New products and services can be developed to better meet members' needs.

One of the biggest benefits of a loan quality assurance program is the communication it fosters between the credit union's various operational areas. Too often we compartmentalize our view of the lending process and limit our ability to see what's best for members. Apple Federal has found the more opportunities departments have to compare notes and see how their areas interact around members, the more successful the credit union is. It doesn't take a detective to see the benefits a loan quality assurance program can provide to your credit union.

DAVID A. REED is general counsel for Apple FCU, Fairfax, Va.

Copyright Credit Union National Association, Inc. Nov 2003
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