The Importance of Annual Reviews

In every aspect of life, individuals, business entities and corporations inspect and monitor their large assets.  Whether that is an investment portfolio, real estate properties or large construction projects. Therefore, it is important to keep an eye on your sizable assets in an effort to avoid any deterioration or loss of value.  Financial institutions are no different; they accomplish this through annual reviews of their larger lending relationships, which inherently have a more substantial risk associated with them.

Facets of an Annual Review

Annual reviews are important for any financial institution to monitor how the business performed over the last year, in an effort to minimize any potential risk of loss for their larger credits.  Annual reviews also help determine whether the borrower has stayed in compliance with any covenants that were set forth when the loan originated.  Annual reviews are important from an inspection standpoint as well. In order to conduct a full and complete annual review, the loan officer or commercial lender needs to inspect the collateral used to secure their asset, especially the non-real estate collateral. 

Adequacy of Collateral

Banks use various kinds of assets as collateral:

  • Livestock and crops
  • Accounts receivable
  • Machinery and equipment
  • Commercial or residential real estate, etc.

As such, banks need to ensure loans are protected by the collateral and have sufficient margin to minimize the financial institution’s potential losses.  To monitor moving collateral, the lender should assess the collateral’s value, condition as well as verify that the borrower still owns and possesses the collateral. 

Loan Grading

The last and most important part of the annual review process is ensuring that the bank’s grade for the credit is accurate and current. This will help the financial institution determine whether it needs to allocate a reserve for a struggling credit in an effort to protect the bank from an unexpected or unforeseen loss.

Annual reviews are a vital process for financial institutions in managing their larger loans and one that sometimes fall through the cracks due to various reasons.  But like every other aspect in life where individuals and businesses monitor their largest assets, banks should continue to do the same thing through their annual review processes.