1. 1March 2015
BY MICHAEL RICE, CHEVY MARCHOSKY AND DAVID ZWICKL
For better coordination between the origination and credit risk management teams,
banks need to adopt an event-driven management approach for underwriting.
A perennial issue in commercial lending is that the under-
writing process seems to defy attempts at systematization.
Inevitably, it seems, contingencies get the best of procedure
in a complex business that depends on fast-paced negotia-
tions between clients, relationship managers and internal
decision-makers. Can the chaos be tamed?
Urgency is rising to address the issue. Commercial banks
are essentially running in place right now, with loan growth
being undercut by shrinking margins. As of the fourth quarter
of 2014, commercial loan spreads had fallen by 100 basis
points from their post-recession peak. There is a pressing
need to streamline the customer experience to capture share
in an intense market. Taming internal complexity is essential
to progress.
Commercial banks also know they need to protect them-
selves by tightly managing credit standards and risk-adjusted
returns. The regulatory community is hammering on this issue
as well, insisting on a more cohesive and better-documented
process for credit origination and management. The Office
of the Comptroller of the Currency, for example, is circulat-
ing proposed guidelines for a risk governance framework
that requires banks to maintain “three lines of defense” that
directly apply to commercial lending, including front line
sales, credit risk management and internal audit.
Perhaps hitting closer to home for executive teams, pre-
cious time is being chewed up in endless micro-discussions
about deals. Managers are not managing a process. Rather,
contingencies are managing the managers. Sales productiv-
ity and customer responsiveness are compromised as atten-
tion is diverted to the details.
To cut through this mess, some banks are adopting
an event-driven management approach that introduces
standards and streamlining techniques for major aspects
of the underwriting decision-making process. These “credit
events” include formal and informal staff interactions in meet-
ings, reviews and conversations.
The goal is to clarify and expedite the major decision-
making categories in the commercial deal pipeline, includ-
ing portfolio fit, deal structure and deal approval. The
ongoing review process for outstanding loans and lines of
credit also needs to be cleaned up. Myriad contingencies
will continue because that is the nature of the business, but
an effective decision framework can make a big difference
in dealing with the crush (Figure 1: Balancing the Workload
for Credit Approval).
FRACTURED PROCESSES
Each commercial banking team will have its own set of war
stories about fractured underwriting decision-making pro-
cesses, but here are two disguised examples that speak to
common challenges across the industry:
Deal proposal. In one instance, a seasoned commercial
banker independently advanced a client conversation to the
deal proposal stage, going so far as to work up a full loan
presentation. The banker put his skills to work in structuring
proposed deal terms of mutual benefit to the client and the
bank, assuming that the energy sector credit likely would
meet the institution’s portfolio criteria (at least based on
career experience).
The banker was crushed, however, when the deal was
shot down during the first conversation with a senior leader
in the credit organization. Though the proposal was solid, the
banker had proceeded unaware that the bank had already
reached its self-imposed portfolio limit on energy sector
Managing Credit Events for
Commercial Performance Improvement
Asseen
in
the

2. 2March 2015
concentration. The credit officer was disappointed to see the
fruitless investment of time, and meanwhile the banker was
blindsided by the portfolio constraint and embarrassed in
front of the prospective client.
Viewing the incident in terms of credit events, the prob-
lem began with poor management communication on port-
folio fit, which left the banker to over-rely on word-of-mouth
information and personal experience. Even after the failure
to proactively convey screening criteria, there still should
have been a process-related safety net in the form of rou-
tine early banker communication with the credit team. With
the benefit of an early conversation, the banker could have
tabled the deal and moved on to other things.
From the regulatory perspective, incidents such as this
highlight the need for front-line sales teams to “own the risks
associated with their activities” and act as a strong first line
of defense. Bankers are understandably focused on growing
portfolios to meet performance objectives but must become
more cognizant of managing the risk profile of the line of
business as well. The early involvement of credit risk man-
agement is crucial in heading off deals that fall outside the
credit parameters of the institution.
Credit approval. At another bank, an overloaded senior
executive decided to review her meeting calendar to under-
stand where her time was going. It quickly became apparent
that her office had become a lobbying destination for bankers
wanting to pre-sell their individual deals before presentation
to the credit committee. She asked around and heard similar
stories from other members of the management team.
The upshot was that the formal credit committee meet-
ing had largely become a rubber stamp exercise, with most
discussion occurring beforehand in office-to-office side meet-
ings. Bankers were tending to shop their loan presentations
with direct managers and every single member of the credit
committee as well — an enormous diversion of time, both for
management and for banking officers.
Figure 1: Balancing the Workload for Credit Approval
The credit committee is often over-burdened in the evaluation of commercial deals in progress and subject to
intense personal lobbying. A more balanced staff involvement is needed going forward (illustration).
Source: Novantas, Inc.
Managing Credit Events for Commercial Performance Improvement
42%
% OF DEAL VOLUME
CREDIT COMMITTEE LESS BURDENED
Breakout of Activity Relative to Total Management Time Devoted to Credit Approval
TODAY FUTURE
CHIEF CREDIT OFFICERS MORE FOCUSED ON EXPOSURE
SENIOR & LINE CREDIT OFFICERS FAR MORE INVOLVED
LOB OFFICERS SOMEWHAT LESS INVOLVED
% OF DEAL VOLUME
% OF DEAL VOLUME % OF DEAL VOLUME
% OF DOLLAR VOLUME % OF DOLLAR VOLUME
% OF DOLLAR VOLUME % OF DOLLAR VOLUME
11%
25%
8%
79%
9%
56%
14%
12%
35%
38%
29%
8%
4%
28%
2%

3. 3March 2015
Viewing the incident in terms of credit events, the core
issue was that the commercial bank’s credit approval process
was ill-defined. Absent a clear and consistent procedure,
relationship managers fell back on the obvious, which was
promoting their individual projects. Amid the disorder, efforts
to systematically balance risk and client responsiveness were
being compromised.
Again from the regulatory perspective, the situation
speaks to the second line of defense — independent risk man-
agement. Splintered talks and deal “pre-selling” can detract
from objective evaluation. In fact, regulators questioned
this institution, wondering why nearly all deals reviewed by
credit committee were ultimately approved.
Along with objectivity in risk evaluation, structured credit
events help to support transparency in decision-making, so
that both regulators and front-line bankers can see consistent,
understandable patterns in deal acceptance and rejection.
This helps to maintain rapport with the sales team through
the ups and downs of credit evaluation.
CREDIT EVENT FRAMEWORK
To properly organize the underwriting and credit manage-
ment process, it is necessary to carefully map out the major
types of events that drive it. This includes the people involved
in the decision-making chain; the right sequence of activities;
and the types of documentation required at various stages.
The logic may sound obvious. But the push from the origi-
nation side is so strong that deal preparations often reach an
advanced state before the credit risk management team is
brought into the loop. The answer is to reorient the workflow
along four dimensions — fit, structure, approval and review
— specifying the collaboration between the origination and
credit teams that will be needed at each stage (Figure 2:
Credit Event Framework).
Fit. An early review of portfolio fit allows the team to get
a collective jump start on promising deals while minimizing
wasted effort on proposals that are “outside the strike zone.”
The discovery starts with client financial statements, basic
company information, industry data and preliminary spread
estimates supplied by a credit analyst.
In a discussion of portfolio fit, the relationship manager
will typically review the client’s qualitative and financial pro-
file, going from there to sketch out a preliminary deal struc-
ture with the direct manager. The focus is on making a yes/
no determination of whether to proceed in developing a term
sheet. Senior leaders are brought in as needed depending
on the client or deal magnitude.
Structure. With a go-ahead on the basis of fit, structure-
related questions begin with a fuller review of client needs and
preferences, plus a collective evaluation of how the working
proposal aligns with the bank’s credit criteria. The objective
in this phase is to craft a balanced term sheet that will meet
Figure 2: Credit Event Framework
A robust credit event framework for commercial lending specifies the collaboration between the origination
and credit teams that will be needed at each stage.
Source: Novantas, Inc.
Managing Credit Events for Commercial Performance Improvement
FIT STRUCTURE APPROVAL REVIEW
Preliminary joint
evaluation of deal
suitability relative to
portfolio standards
and objectives
Joint formal review
of client profile,
needs and potential
risk-adjusted
returns, leading to
creation of initial
term sheet
Business Unit
Signature
Approval
Credit
Committee
Review
Credit
Signature
Approval
Quarterly and
annual reviews of
outstanding loans
and lines of credit,
including updated
client information
and reassessment
of risk

4. 4March 2015
hurdle rates of return, protect the bank from downside risk and
win internal approval, ready for delivery to the client.
Approval. The preliminary approval meeting includes the
relationship manager, senior bankers and credit staff, and
it culminates in the release of the term sheet to the client.
Upon client approval, a formal internal loan presentation is
prepared. The formal approval meeting includes a deeper
evaluation of the company’s financial condition and under-
writing considerations. Once the credit terms are finalized,
the client is notified and legal documentation commences.
Review. The credit team continues its involvement with
outstanding loans and lines of credit via periodic reviews,
either quarterly or annually depending on the type of facility.
Updated client financial information typically is required for
these meetings, and risk factors are recalculated to ensure a
continuing fit within the original credit terms. The review pro-
cess also extends to renewals, although the level of required
effort typically is lower since the institution already has com-
plete customer information.
Again from a regulatory perspective, periodic reviews
can accomplish many of the best practices prescribed for the
third line of defense, even though they are not conducted by
an internal audit group. Once a uniform review structure is
in place, the internal audit group can monitor the process,
helping to quickly identify and mitigate risk. A robust review
process also encourages strong data governance, given
requirements to update customer financial data and risk pro-
files at regular intervals.
Across all of the credit event dimensions — fit, structure,
approval and review — each of the three regulatory lines of
defense must work in tandem to balance the return on the
portfolio with the credit risk appetite of the institution. Left
untended, weak governance practices will inevitably lead to
lapses in credit risk management, with potentially severe con-
sequences, both regulatory and financial.
HAPPY MEDIUM
While credit events need to be well-defined, this does not
imply an underwriting straightjacket, as both RMs and
the credit staff need flexibility in responding to the unique
requirements of each transaction.
Banks tend to veer to the extreme, either imposing a restric-
tive, one-size-fits-all process or having little apparent structure
at all. The key is to find a happy medium, tailoring process
and documentation standards for major deal types, sizes and
lines of business, supported by a general framework.
Well-structured credit events provide three main benefits:
Improved customer experience. Promising opportunities
can all too easily evaporate in the face of long cycle times,
miscommunication on key aspects of a negotiation, or unsat-
isfactory dealings with individual bankers. Structured events
provide a common foundation for the origination and credit
teams, permitting deal creativity and quick responsiveness
while protecting underwriting standards.
Risk/growth balance. Structured credit events facilitate
the proactive co-involvement of the origination and under-
writing teams. Often today, growth is emphasized at the
expense of the formal review process. In the future the two
factors must be much better balanced, with credit risk screen-
ing providing a more timely and effective line of defense.
Regulatory compliance. Commercial banks are expe-
riencing new levels of regulatory scrutiny and compliance
pressure, as reflected in the OCC’s three lines of defense
and in stress-testing prescribed by the Fed’s Comprehensive
Capital Analysis and Review (CCAR) and the Dodd-Frank
Act Stress Test (DFAST). Strong data management is critical in
compiling the more lengthy internal data series, generating
more the more detailed credit loss analytics, and drafting the
more thorough documentation that regulators are requiring.
Credit events provide an audit trail for each transaction
and assure data capture by specifying required inputs and
outputs at each stage in the process. They also provide a
new level of process transparency, valuable for executive
management, business line management, risk management,
compliance, audit and financial management.
QUEST FOR CLARITY
There is no single solution for implementing efficient and
effective credit events. Organizational styles differ, for
example, with some institutions placing a heavy emphasis
on credit committee approval, and others using signature
approval for the vast majority of loans. Each bank will need
to clarify the processes that will best support its preferred
approach, and then follow through with a determined effort
to instill the appropriate credit event standards into the origi-
nation and underwriting workflow.
One requirement is constant across banks, however,
which is that the framework for credit events needs to be well-
defined. This is essential in streamlining origination, under-
writing and portfolio management processes for improved
customer responsiveness in an intense market; protecting the
risk profile; and meeting regulatory expectations.
Michael Rice is a Managing Director, Chevy Marchosky is a
Principal and David Zwickl is a Manager in the Chicago office of
Novantas Inc. They can be reached at mrice@novantas.com,
cmarchosky@novantas.com and dzwickl@novantas.com.
Managing Credit Events for Commercial Performance Improvement