THE BENEFITS OF LOAN DOCUMENT IMAGING AND DIGITAL LOAN PORTFOLIO MANAGEMENT

Benefits of Loan Document Imaging and Digital Loan Portfolio Management

Banks that have successfully implemented document imaging applications, developed comprehensive polices and diligently follow consistent procedures reap the benefits of efficiencies in loan portfolio management (even more efficiencies if the bank does enterprise-wide imaging), increased productivity, diminished loan policy and document exceptions and streamlined audit and examination processes. Advantages to installing and managing a digital loan portfolio system can be divided primarily into two specific definitions: tangible costs reduction and intangible costs mitigation. This paper will address both definitions and further illustrate the savings to a bank in bottom line, staff resources and compliance.

The state of loan document imaging today

Surveys amongst banks, auditors and regulators have determined that electronic loan management is the next large technology investment community banks are planning. Many banks had made the strategic decision to move ahead with implementing document imaging systems to eliminate the manual loan file management processes that have been in place since banks began lending money. The turmoil in the global economy beginning in the late summer of 2008 delayed the start of most of these decisions to move forward. The prevailing attitude was if it aint broke, dont fix ityet. Unfortunately for many financial institutions, their plight was amplified by the innate inability to manage their loan portfolios efficiently, track and cure exceptions timely and appease auditors and examiners by their inability to identify and grade loans because of the sheer volume. The upheaval in the financial industry only exacerbated the banks issues as more problem loans were identified and classified. This resulted in the allocation of more time and more resources to solve problems already booked in the loan portfolio. In the past few years many community banks have successfully deployed branch capture of checks and on-line banking. However, today most community banks still manage their loan portfolios with paper based filing systems. After consumer and commercial loans are booked, documents are placed in physical paper file folders containing 6 to 10 tabs and filed away in the filing cabinets located in a file room. As new documents, such as perfection or collateral documents or annual financial and insurance updates arrive they are processed. The file is pulled and the documents are, hopefully, placed under the designated tab within the file and then re-filed back into the filing cabinet located in the file room. This process is continued until the loan is paid off. Electronic loan management is similar in the concept and follows a similar workflow as the paper process with a few technological advances.

An overview of basic electronic imaging processes

With an electronic file room all credit and loan documents are scanned after booking in an electronic document repository with a similar tab structure as the paper file. These scanned images are then stored within the electronic repository in open architecture format. These images are stored and reside on the banks server. 2

The most basic electronic repositories are not designed to be industry specific and usually do not lend themselves well to managing bank loan portfolios. Loan portfolio management is quite specialized and requires a user-friendly interface since lenders and other non-technical users are often the main user group. Presently, bank specific repositories are offered by bank core providers as well as by third parties. Key features in a good bank specific repository will include the ability to deal with multiple/cross collateral loans, related entities and multiple guarantors. The repository should have the ability to hide employee loans through security features while still remaining extremely user-friendly. Some systems have the ability to set up demographic information as well as the various collateral and loan types with all appropriate tabs automatically through a nightly download from the banks core software. Advantages of a basic document repository system versus paper is that documents are available at the time they are needed and since the documents are immediately scanned after booking the loan or later receipt they are much less likely to be missing or lost. Some banks that employ a basic system will often continue to maintain a dual system with their paper-based process. They will also continue their independent tickler system that may be provided by the core, another vendor or an inhouse built system, usually an Excel spreadsheet.

Advanced imaging and loan portfolio management

More advanced imaging systems will combine document loan management and include various file management abilities in addition to a basic repository. These advanced systems track missing, expired, or out of compliance documents along with integrating all the various aspects within loan management such as the loan perfection process, technical exceptions, internal auditing and compliance requirements. They are able to replace the various ticklers and exception management systems banks will still need with a basic repository. Banks no longer need to manage multiple systems and mitigate the need to manage most paper with the exception of instruments of security. The more advanced systems will also have the ability to set up the various typical exceptions and parameters automatically through a nightly core download that includes document, technical and policy exceptions as well as the ability to track loan classifications. The exception requirements should be dollar and date sensitive as well. The most advanced systems, although scarce, include everything discussed so far and have the ability to automatically assign tasks such as assigning exceptions to officers or other staff responsible for clearing loan exceptions. At this advance level, these systems can also send various reports via e-mail on a scheduled basis to assignees and management that also contains summary reports with critical loan information status. Additionally, the system will have the ability to print letters and notices that can be mailed or delivered electronically to customers.

Regulatory oversight and audit preparation

Based on actual audit and examination findings, it has been perceived that financial institutions have been lax and careless in their governance and oversight of lending functions and overall portfolio management. The legislative branch of the US government has responded by publicly castigating federal 3

banking regulators for not being more proactive in their identification of problems in banks before they became critical to the point of banks failing. Between January 1, 2009 and July 31, 2009 sixty-nine commercial banks have been closed in the US. In addition two corporate credit unions and one individual credit union have been placed in conservatorship. When the heat is turned onto the regulatory agencies then banks also get burned by increased oversight, more regulations and constant monitoring of policies and procedures. There are many reasons why financial institutions fail: lack of capital, asset quality, liquidity, etc. But for many failures the underlying factor was the inability to properly manage their loan portfolios and to identify problem credits early. Advanced loan document and imaging applications incorporate automated processes to enable loan support staff to prepare for audits and examinations more efficiently while shortening the amount of time and research required when the programs and applications are properly maintained. These applications should have integrated into them loan document and policy exception detection processes that proactively identify and report them so that they can be corrected as a best practices measure and definitely before the exam begins. Digital management of the loan portfolio means that exceptions can be resolved immediately and efficiently. Preparation of audits and exams can now take a few hours instead of days. Examiners and auditors see many positive ramifications of a digitally managed document system: consistency in loan file tab layout; less travel and out-of-office hours when requested loans are presented on a CD or DVD; less time poring over paper files with missing or misfiled documents. For a banker it means less time the examiners and auditors are in the bank. A fully integrated digital loan portfolio management system will accumulate and organize all of the required data for a successful loan review.

Integration of related functions

Other loan management related functions are being integrated into loan imaging and portfolio management. One is the loan approval process routing and documentation of the individual loan approval processes as well as the ability to attach all credit related documents to the approval process. Another is the linking and integration of imaging and the document preparation systems such as LaserPro, Easy Lending and Compliance One to name a few. Documents can be electronically signed through the use of signature pads and then imported into the imaging system without having to be printed and rescanned. Loan review with its related workflows is being integrated into electronic loan management. Loans can be flagged for reviewers according to aggregate dollar amounts, loan types, etc. Loan reviewers are then able to review the credit file and the collateral file and have several statuses to rate them. Loan grade changes can also be requested in this manner. 4

Determining value for loan document imaging and portfolio management

A value proposition that contemplates processing changes must possess the ability to address and solve the banks business needs. Loan document imaging is often mentioned as the cure-all for solving loan document management needs. Many vendors are offering a wide variety of document imaging with different levels of capabilities from basic non-industry specific repositories to more advanced financial repositories and to the most advanced level with integrated document management, exception reporting and true loan portfolio management. Before we can discuss what changes need to be made we must first determine the factors that are forcing change and innovation. Important factors within community banks, their business models and regulatory and competition issues have a profound impact and are forcing banks to re-evaluate their paper based loan management processes. Bank management and loan department support staff are realizing that paper-based processes have serious shortcomings within todays changed environment. Every bank can identify with this list of factors that are impacting community banks and are forcing them to make changes and implement innovative ideas into the management of their loan portfolios today. Obviously, each bank is unique and this list is not intended to be all inclusive. It does, however, stress the main points we have discussed. Regulator pressure to implement additional policies and procedures for increased control and management governance and compliance. Unacceptable exception levels with independent exception tracking processes, often manual systems. Growth is forcing banks to streamline loan operations. Technical knowledge to manage loan portfolios is hard to find and expensive. Loan management is becoming more cumbersome partly due to mergers and acquisitions, multiple branches and charters. Banks need to look for ways to reduce costs in loan management. Remote check capture is reducing the need for expensive couriers. Loan document imaging can do the same thing. To stay competitive, banks are adding branches farther away from the home office and these branches need access to loan files.

Determining what processes to change

We have discussed the underlying or overwhelming factors that are forcing changes in the methods that banks presently use to administer their loan files. Now in order to continue to determine value we must 5

identify what changes need to be made. The basis of any investment decision must always start with the question of what problem the bank is trying to solve and to compare that solution with the potential value and risk involved with migrating to an improved system. One typically focuses on the processes and more importantly the potential process that the bank is contemplating. A needs analysis will guide the bank through the process of identifying the current processes and will reveal the unsatisfactory processes the bank wants to improve. Then by prioritizing the needs, the outcome will assist in developing a more clear roadmap for the bank to follow to determine the level of document imaging and portfolio management it needs to solve its problems and will make the vendor selection process easier. A good match would require the vendor selected to satisfy all or at least most of the requirements that the bank has developed. No matter what the level of application, each contains its specific value proposition. If a bank is intending to make accessibility of documents its main objective, then a non-industry specific may be a good match. The same application may fail if the bank is intending to track multiple/cross collateral as well as policy exceptions and officer notes. A bank will need to determine what level of application will provide the most assistance in the audit and examination process. Typically, the more processes within a loan management application the bank is integrating the greater the value proposition. Earlier in this document we mentioned that benefits will be derived in not only compliance and efficiency but also tangible and intangible costs. We will now discuss in more detail the tangible and intangible benefits. Tangible cost benefits are typically tied to the physical aspects of setting up loan files, storing loan files and moving paper documents from one location to another. These measurable costs include: Physical space cost: Space savings depend largely on the physical location of the files. Some files are kept in vaults that would be challenging to convert into usable office space. If files or a portion of the files are housed in file cabinets within the work space then the ability to convert the storage area into productive work area exists. Accessibility of documents: Paper documents can be in only one location at a time. Accessibility to documents can be broken down into several needs. A bank with several branches needs to identify the costs involved in moving files from the branch to the main office. Labor costs will be included in the amount of time needed to set up new paper files; filing new documents when they are received; following up with users who have not returned files; locating missing or misplaced files; making copies of files for internal users who request them; archiving items for off-site storage and the cost for off-site storage services and then finally making room for a growing inventory. Travel of documents or people: In a centralized loan management environment, all loan files are housed at one central location. If paper loan files are requested by a branch they are most often delivered by courier. At some banks, the files are copied first or scanned and emailed. In a de-centralized environment, each branch houses their loan files and auditors will have to travel to the various locations

to perform loan reviews. Sometimes the branch will ship loan files that are needed for the audits to the centralized location for auditing. File cabinets and file folders: The most obvious and easiest to cost benefit to calculate is the cost of file cabinets and file folders. These costs are directly related to loan portfolio growth and new branch openings. New file folders are needed because each new loan is housed in a new file folder. Intangible costs are real costs that are not easily calculated but still have an important impact on the banks decision to make changes. Intangible costs include: Mitigating the risk of manual ticklers: Banks that manage their loan portfolios with paper are forced to utilize separate manual ticklers and reporting that are not tied directly to documents, exceptions and tasks. Seldom are these manual ticklers in sync with the contents of the paper files. This forces banks to deal with the effects of having missing documents because they were not added to manual ticklers or the opposite effect when the tickler reports missing documents that are actually in the file but were not removed from the tickler when the document was received and placed in the file. The costs can be staggering when the document in question was not perfected or is missing an insurance certificate in the likely case of a claim. Non-standardized loan document structure: Unacceptable variations can be detected in document setup by lenders, loan administration staff, branches, regions and charters with the same loan type. This can cause embarrassment and unnecessary criticism by auditors or examiners since the requested document may actually be in the file but in a different location than expected. Disaster prevention and cost of destroyed or damaged documents: Disaster prevention or recovery is almost impossible with paper documents. They can only be at one place at a time. Fire and water can destroy entire loan portfolios that cannot be recreated. Floods and other disasters have shown how quickly they can create great havoc. And what bank has not lost individual documents or entire loan files at one time or another? Not being customer service oriented: As mentioned earlier, a paper document or loan file can only be at one location at a time. With a centralized loan management system it often means that when a customer approaches a loan officer at a branch with a question, the file cannot be accessed.

Conclusions
When comparing the expense of installing a new document imaging system to the tangible and intangible savings of moving from a paper system, the costs can usually be recovered in one year depending on the level of the sophistication of the new system. The first year will be the most expensive for acquiring and implementing the new system. Costs will typically include the expense of buying a server and scanner, the initial software and the internal labor 7

costs of scanning the banks present loans. But after the first year, ongoing costs would be for support and the occasional hardware upgrade. It will take up to one year to fully exploit the savings of any new system. To reiterate, the savings will be comprised of administrative labor, lender labor, reuse of filing cabinet space, elimination of travel for loan review and the elimination of file folders. Internal bank labor, both for administrators and lenders, comprise a substantial amount of savings. And even though they are primarily fixed costs, the savings will enable the bank to continue growing without adding FTEs.

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AccuSystems, LLC 3921 Outlook Blvd, Pueblo, CO 81008 (719) 583-8004