7 Core Principles For Managing A Credit Portfolio

I recently sat through a credit symposium where the company’s chief credit officer spoke on his lessons learned from his 20 years managing and balancing credit risk with business growth. Here’s what he said.

  • Focus on Horizontal P&L
    • What is the value created over the life of the decision? (vs immediate P&L impact) And what is the shape of the earnings stream? 
    • I feel like this is a pretty basic core principle where the earlier your cash flows are, the less risk you take on (less interest rate risk, less volatility risk, less charge-off risk), so it wasn’t terribly insightful in that sense. Where it was insightful, is the massive premium (or weight) he puts on this, and what he’s willing to give up to get it sooner, rather than later.
  • Core Objective is Achieving Sufficient Returns for Risk, Not Minimizing Risk
    • I think felt this was a pretty basic example of NPV and properly grounding the expected payoffs. Where I see him take this to the next level is “truly” understanding the downside risk, and not just something the models/historicals spit out. E.g. If your model is wrong, or risk is double what you project, will it take the business under? If so, can you catch that early enough and stop that from happening?
  • Obsessive Focus on Resilience
    • Ensuring acceptable performance if losses or other performance drivers are worse than expected (and worse than the past).
    • This goes back to the point above. It’s not really about minimizing risk, but rather optimizing returns; with the caveat of making sure you don’t break the business if your assumptions are wrong.
  • Marketing and Credit Are Inseparable
    • “Credit Decisions” are defined broadly; it includes pricing, product, channels, incentives, and other factors that can impact credit performance and resilience. 
    • I think what he means here is that pretty much everything you do in the lending business will impact your credit risk. E.g. if you decide to go big on a specific marketing channel, you’re essentially targeting a segment of customers that can be reached via that channel. That channel will shift the weight of customers that come to your door for credit. Though your credit policy may be designed to only approve segments you’re traditionally comfortable with, you’re still shifting the weight of your portfolio towards that segment, which isn’t reflective of the full population you had previously expected.
  • Few (or No) Volume Goals
    • Business people can be rewarded for walking away from bad business, not just booking good business.
    • I think this is such a powerful message that all businesses should have. It’s being able to say No when it doesn’t fit the company’s long-term goals and strategic agenda. However, I’ve yet to see people really rewarded for this. I think he left out, “you’d better have a plan to follow with it that will bring us back to the path of green and to limit the damage of all the red you did.”
  • Both First and Second Line Expected to “Own” Credit Risk Outcomes as Part of an Integrated Business Strategy
    • Not just maximizing a single part of the equation (like getting volume, minimizing losses, etc).
    • I take this to mean that everyone is responsible for the outcomes. You always of the first line of defense, the business (individuals/teams incentivized to grow) and the second line of defense, the risk office. Though the upside is owned by the first line, the downside should also be owned by the first line, not just the second line (as I have seen in most companies where the two are constantly pitted against each other). Not to say that its not true here, but for strategies that do have long-term potential downside risk, the owners of those decisions don’t get immediate payouts (rather their strategies must prove themselves first).

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