Western Banker - November/December 2016 - 7

'' Risk tolerance and risk appetite are often used synonymously, but they are different. You may be thirsty for a six-pack of beer, but your tolerance is unlikely to accommodate more than two or three cans and still allow you to legally drive. '' classifications of special mention, substandard, doubtful and non-accrual. Classified loans exclude special mention but do include substandard, doubtful and non-accrual. Generally speaking, loans past due 90 days or more are monitored because they are probably ripe for classification as non-performing loans. As credit officers try to portend the future, some rely on a "30-30" rule-of-thumb measure; 30 percent of criticized loans are likely to decline into non-performing status, and 30 percent of the non-performers will go to charge-off. Figure 1 offers a typical format for tracking AQ performance, and the color coding offers another way of addressing performance in terms of risk tolerance: Asset Quality (AQ) One good reason to employ these measures is that both the market and the regulatory community watch these ratios closely: * Loans delinquent 30 days or more as a percentage of total loans * Criticized loans as a percentage of total loans * Classified loans as a percentage of total loans * Loans delinquent 90 days or more as a percentage of total loans * Non-performing loans as a percentage of total loans * Net charge-offs as a percentage of total loans For those less familiar with these measures, criticized loans include those loans judged to fall into the regulatory Figure 1: Asset Quality Performance in Basis Points (bps) for Right Bank Measure RT Limits Year 1 Year 2 Year 3 Year 4 30 days pd .50-.75 .50 .60 .75 1.25 90 days pd .05-.10 .01 .10 .12 .25 CriƟcized 1.25-1.50 1.25 1.30 1.50 2.60 classified .25-.75 .50 .60 .80 1.50 Nonperforming .05-.10 .02 .04 .10 .35 NCO's .25-.50 .02 .05 .35 .75 Red: performance is worse than Risk Tolerance (RT) limits Green: performance is beƩer than RT limits Mark Twain once remarked, "It used to be a good hotel, but that proves nothing - I used to be a good boy." Like Twain's hotel, Right Bank's loan portfolio performance has worsened over the four-year period, but back in Year 1 and Year 2, its performance was actually a little better than the risk tolerance (RT) limits. The RT limits ought to be set with maximums reflecting levels excessive to peer banks. Such data is readily available from several sources, including the regulatory agencies. On the other hand, operating too tightly - i.e., better than the competition - may suggest the bank is not taking enough risk. Risk tolerance and risk appetite are often used synonymously, but they are different. You may be thirsty for a six-pack of beer, but your tolerance is unlikely to accommodate more than two or three cans and still allow you to legally drive. Risk tolerance must take into account the bank's cost of funds, credit risk premium and hurdle rate of return. Nevertheless, a basic drawback to the AQ measures, especially the classified loans, is that by the time these are recognized, the damage has been done. The savvy portfolio manager looks for other indicators of potential problems, and these are sometimes referred to as credit administration measures. Western Banker November/December 2016 7

Table of Contents for the Digital Edition of Western Banker - November/December 2016

A Message from the President & CEO
Back to the Future to Manage Portfolio Performance
The WIB App Store
Managing Your Bank’s Reputation by Taking an “Inside-Out” Approach to Communicating News
Interest Rate Risk and ALM: Most Institutions Are Doing it Wrong
Everything Old is New Again — Updating FCRA Compliance in a CFPB World
Professional Development
Secrets to Employee Engagement for Bank Managers
March of the Millennials: Cultivating Relationships Within the Digital Generation
Welcome New Members
Index of Advertisers
Western Banker - November/December 2016 - cover1
Western Banker - November/December 2016 - cover2
Western Banker - November/December 2016 - 3
Western Banker - November/December 2016 - 4
Western Banker - November/December 2016 - A Message from the President & CEO
Western Banker - November/December 2016 - Back to the Future to Manage Portfolio Performance
Western Banker - November/December 2016 - 7
Western Banker - November/December 2016 - 8
Western Banker - November/December 2016 - 9
Western Banker - November/December 2016 - The WIB App Store
Western Banker - November/December 2016 - 11
Western Banker - November/December 2016 - 12
Western Banker - November/December 2016 - Managing Your Bank’s Reputation by Taking an “Inside-Out” Approach to Communicating News
Western Banker - November/December 2016 - 14
Western Banker - November/December 2016 - Interest Rate Risk and ALM: Most Institutions Are Doing it Wrong
Western Banker - November/December 2016 - 16
Western Banker - November/December 2016 - 17
Western Banker - November/December 2016 - Everything Old is New Again — Updating FCRA Compliance in a CFPB World
Western Banker - November/December 2016 - 19
Western Banker - November/December 2016 - 20
Western Banker - November/December 2016 - Professional Development
Western Banker - November/December 2016 - Secrets to Employee Engagement for Bank Managers
Western Banker - November/December 2016 - 23
Western Banker - November/December 2016 - March of the Millennials: Cultivating Relationships Within the Digital Generation
Western Banker - November/December 2016 - 25
Western Banker - November/December 2016 - Index of Advertisers
Western Banker - November/December 2016 - cover3
Western Banker - November/December 2016 - cover4
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