By Stephen A. Enna, John Parry & Alexander

Congratulations you have been appointed a member of the Director Loan Committee. So what now? How do you approve loans as a member of the board Loan Committee when you have never made a loan in your life?

Let’s start with the fact that lending is not as complicated as many people believe; but, do not underestimate the fact that a sound lending practice is absolutely critical to the success of a community bank. Nothing can make a community bank fail faster than a single or series of bad loans.

You may have heard of the three “Cs” that set the foundation for lending. If not, they refer to the character of the loan, the bank’s capacity to make the loan and the credit worthiness of the borrower. These combine to set the foundation for a sound lending practice.

As a member of the Director Loan Committee you should be aware that lots of things have taken place before a loan ever reaches your level for approval. There are many people involved in the process below the Board level working to assist you in making the right decision. This is an active process with lots of give and take internally. As you might image, most of the people involved are very serious and helpful; on the other hand, I’m sure there are a few who try desperately to contribute but have nothing relevant to add yet they just keep trying. Most of this stuff gets sorted out before you ever see a loan but it does lead me to my first recommendation. That is when it comes to making a sound loan decision, listen to those you trust and ignore those that you do not.

The second recommendation is to educate yourself on the following:

• The basic lending principles and lending processes in place in the bank
• Delegations and levels of authority
• The financial and operating risk analysis process
• The bank’s required rates of return
• The bank’s exposure limits
• Prohibited/restricted areas of lending (e.g. family members and illegal activities.

It should be noted that risk can be divided into categories:

• Credit risk,
• Interest rate risk,
• Liquidity risk, and
• The bank’s capital risk

It is important that you educate yourself in each of these areas.
As to loan conditions, you should be aware of the bank policies regarding the following:

• Terms of lending
• Facility structures
• Pricing
• Security/Collateral
• Covenants

Most banks have policies that cover both principles and conditions. Some are simply guidelines as opposed to firm rules that are not to be broken. You should be aware of what the rules are. You should also familiarize yourself with the bank’s attitude toward risk. There is lots of intense focus on risk management and generally you will find that most banks take a conservative policy toward this issue.

Third, your ultimate decision will depend on a number of factors but should be based on a foundation described above. It starts with the quality of the borrowers and whether the loan fits with the business strategy of the bank. The other issues of importance should include a review of the risk associated with the loan, the price and the return on equity.

In the end a great deal of lending acumen comes down to common sense and a proper amount of homework. If there is something about the deal that just doesn’t seem to make any sense keep asking questions until it does or turn the thing down.

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