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ComplianceOctober 11, 2022

Effective lien management critical to creating bulletproof risk appetite statement

(As published in ABF Journal, October 2022)

In the first half of a two-part series, Suzanne Konstance of Wolters Kluwer Compliance Solutions explains how lenders can improve their risk management processes and portfolio performance by effectively managing liens.

Risk officers are part of a critical line of defense within a financial institution. More than anyone else, they are responsible for providing input on key risk decisions, tracking risk across multiple business lines and underwriting compliance with their institution’s risk appetite statements and policies.

It’s an extremely challenging position that can also include the management of general and targeted loan reviews on banks by regulators. Partially in response to such regulatory audits — and as a best practice exercise — many banks now perform such ‘loan reviews’ periodically as part of their standard internal processes, often through credit risk and/or internal audit reviews. The reviewers typically choose a portion of the bank’s portfolio and examine its ongoing credit characteristics, including lien perfection. This important work relies on information that comes from various sources, including audit findings, regulatory findings and risk limit reports. But what if the information is incomplete? What if the data is full of assumptions and not facts?

A holistic approach to loan risk management

Risk officers are also typically working to strengthen the internal guidelines that ultimately result in a risk appetite statement (RAS). Any RAS is designed to help an institution make the right decisions with respect to the types of risk it’s willing to take on, as well as the types it isn’t.

Without complete information about loans and UCC filings, it can be difficult, if not outright impossible, for the RAS to accurately reflect an institution’s position on risk. Let’s look at a fundamental but crucial area of lending as it relates to portfolio risk reviews: ensuring lien perfection.

With respect to liens, secured loans are often taken for granted as part of a risk defense foundation. They are thought to be protected, stable. Unfortunately, that view is often inaccurate.

  • A recent Wolters Kluwer review of nationwide public financial filings revealed that approximately 20% of liens contain a critical error that could invalidate any claim to collateral. Additionally, 16% of debtors have a change event each year requiring lien maintenance activities, while up to 32% of liens lapse annually, resulting in a potentially premature loss of position.
  • One of our clients had $900 million of loans secured by 3,600 liens. When we examined the client’s portfolio, we discovered that 760 of its liens contained some sort of error that could cause it to lose first position on the loans. That would make up 21% of the client’s portfolio, representing a total of $190 million in risk exposure. And this level of risk exposure wasn’t an outlier. As noted earlier, our research of public records revealed there to be issues in an average of 20% of lender portfolios across the board.

There are several ways in which imperfect liens can taint a lender’s portfolio. New loans added to a lender’s portfolio may contain/ possess/harbor imperfections that may pass unnoticed through the first line of risk defense due to the urgency in closing those loans. High loan volumes can tax the capacity of a loan operations department and create an environment that allows a certain percentage of problematic issues to be missed. And, of course, the COVID-19 pandemic has exacerbated workflow errors for reasons ranging from the impact of operating in a remote work environment to a reduced number of employees executing a particular loan.

The risk that errors in lien filings can bring to a bank can be multiplied by many jurisdictions in which it finances loans and the types of collateral used to secure a loan. Lenders that work across multiple jurisdictions or even in all 50 states have significantly more risks and complexities to manage. But even the smallest lending institution needs to ensure it has a strong lien risk management framework in place to avoid unsecured lending events because without the full picture of data, a risk officer can do all the right analyses and seemingly make all the right decisions and still, at the end of the day, come to the wrong conclusions.

The role of the risk team when it comes to lien management

Lien management affects a financial institution’s risk profile in a significant way and, accordingly, should be a part of a risk officer’s daily agenda. Historically, liens have been viewed as binary, i.e., they were considered to be either secured or unsecured, so the complexity that exists with liens was not even on lenders’ radars. But locating the loan review process within a bank and seeing how lien perfection is managed can provide useful insights about how and where a bank is vulnerable to risk.

To get to the root of lien management in your institution, start by asking the following questions:

  • What is your process for assuring, tracking and updating lien perfection?
  • Do you oversee any assets that are originated externally to the bank?
  • What reports are created that track loan perfection for the assets you oversee?
  • Is lien perfection information fed to higher- level systems or reporting?

The answers will reveal a lot about both strengths and weaknesses in an institution’s processes.

In part two of this series, we’ll look at some specific examples of data variability and how advances in technologies such as artificial intelligence are ushering in a new era of data transparency and access to lien and debtor data. These advancements can help financial institutions better understand the nuances of their secured position and empower them to take more informed decisions. From loan operations to the chief risk officer’s desk, it’s advantageous to have the data that matters most.

Suzanne Konstance Vice President of Product Management and Marketing
Vice President Product Management and Marketing
Suzanne is Vice President and Leader of Lien Solutions, a top UCC, real property and vehicle titling and lien service in the US and a business within Compliance Solutions.
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