Problem Loan Management – Evaluation of Performance and Modifications
This blog was authored by my colleagues Erica Crain, Manager of National Credit Risk Services and Monica Bolin, Director of National Credit Risk Services. In this three-part series, our goal is to provide considerations for evaluating the overall problem loan management function as we continue to navigate the economic impacts of the COVID-19 pandemic.
In the next part of our problem loan management series, we turn our focus to financial analysis, frequent monitoring, and how to account for special considerations such as loan modifications and extraordinary items on financial statements.
One of the critical aspects of loan underwriting is ensuring the financial analysis and source of repayment are well-documented and supportable. When a loan reaches your problem loan management group, the first question is “How did we get here?” and quickly turns to “Where do we go from here”? The dialogue between lenders, borrowers, and the problem loan management team that occurs in these early stages is crucial. Documenting a detailed analysis of all repayment sources is essential and should include options for the borrower to repay including short- or long-term loan modifications. Furthermore, the translation of these identified risks to the assigned risk rating of the credit(s) through the process is imperative.
The events of 2020 not only presented new challenges for borrowers but also introduced special considerations for financial institutions to consider in evaluating borrower financial performance. More specifically, tax returns and financial statements for the year will include various unusual items that need to be assessed. Government-assisted credit facilities provided participating borrowers with funds that would not have otherwise occurred and were not present in prior periods. Completing year-over-year comparisons to truly identify the impact of COVID-19 will require elimination of these “extraordinary” items. For example, eliminating funds received and/or forgiven through the Small Business Administration’s Paycheck Protection Program will be essential to review “core operations”. Financial institutions will need to consider how core performance would have met the requirements of the original loan terms and covenants before any concessions or modifications were granted. While it is accurate to analyze actual cash flow, potentially with the inclusion of funds from a government-assisted credit program, it is pertinent to a sound problem loan management function to remove the noise, so-to-speak, and evaluate how the borrower is functioning at its core without assistance.
Loan modifications have been instrumental and encouraged to assist borrowers negatively impacted by COVID-19. To be clear, just because a loan has been modified due to COVID-19 does not mean that it is automatically a problem loan. Simply stated, the loan modification does not equate to a problem but is an indicator of what kind of assistance or relief the borrower might need during a problematic time. However, modifications do tell part of the borrower’s story that needs to be considered. For example, when multiple loan modifications are necessary or extended periods of deferred payments or interest only periods are made, it is important to consider the underlying issue. How long is the impact projected to continue and at what point does the loan potentially become a problem credit?
Additionally, evaluating reliance on guarantor support during this period of stress could also indicate how much the borrower has been impacted by the COVID-19 pandemic or other issues with negative implications. This analysis will be informative for a financial institution regarding the level of problems or obstacles facing the borrower. As a result, the financial institution can begin to decipher which loans require additional monitoring and those which require action plans with a goal to effect positive change in the course of the credit.
In the last and final part of this series we will dive into developing action plans to address problem credits and special considerations for overall problem loan management as the pandemic, and its ripple-effect impacts, persist.
How Can We Help?
CLA can help you navigate the challenges of problem loan management. Our credit risk management team is comprised of long-term industry professionals with experience in problem loan management. Join our webinar on March 2, 2021 where we will discuss this topic and answer your questions. Watch for the last in our three-part series of blogs on this relevant and timely topic.
Susan is a CPA with more than 20 years of combined experience in public accounting and the financial institution industry, including experience with Fortune 500 financial services companies. Susan serves as the managing principal of CLA’s financial services group. Her responsibilities include providing engagement oversight in the areas of assurance and internal audit. In addition, Susan provides board advisory and management consulting services in the areas of strategic planning and mergers and acquisitions. Susan has been involved in multiple mergers and acquisitions of sizes ranging from $150 million to $500 billion with engagement at all stages of the process.
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