Problem Loan Management – What is it?
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.
By definition, a problem loan is one that cannot be repaid according to the terms of the initial agreement, or in an otherwise acceptable manner. But, in a time when payment deferrals and payment modifications are numerous and government assistance loans are necessary, how does the definition or at least identification of a problem loan change?
As 2020 unfolded, we continued to encourage our financial institutions to evaluate policies and procedures governing the credit risk function. The annual review of policies and procedures is generally required and often met with a lack of enthusiasm at all levels. However, financial institutions responded quickly at the onset of the pandemic in March 2020 and in many cases did not pause to document their response. On the forefront were loan modifications and loan programs – including government-assisted credit facilities – that were unlike anything seen in the past. Extraordinary times call for extraordinary measures.
Most financial institution policies and procedures are written to address “normal operating procedures”. By updating these guiding documents to address approved actions (such as modifications, monitoring, reporting) that have been or will be taken in the “new normal”, management is demonstrating the safe, sound, and prudent actions expected by regulatory bodies. Clearly identifying what the financial institution considers a problem loan is critical not only for the policy but also to provide clear direction to responsible parties in the lending and risk functions.
Next, consider the resources available to you internally with experience in managing problem loans. Who are the experienced parties you’ve identified to lead the problem loan management program and what responsibilities do they hold? This is an important guiding step in successfully managing problem loans. As mentioned in previous posts, it had been more than ten years since the end of the Great Recession of 2007-2008 when the pandemic was declared. Many lenders have not been exposed to problem loan management since that time or further, some lenders have not been in the industry long enough to experience an economic downturn. The art of problem loan management involves objective parties, and in many cases, a group that is independent of the loan officer to ensure the borrower’s situation is being managed in a way that is effective for all parties. You may quickly realize, or may already have realized, that your problem loan management program needs additional support.
One of the critical pillars of problem loan management remains frequent monitoring of the credit portfolio. Early risk identification can be accomplished through internal annual and other periodic reviews. This step requires collection of updated financial statements and other information pertinent to monitoring the financial wherewithal of the borrower, guarantor, and related entities on a standalone and combined basis. Instead of deferring the collection of financial information from borrowers during this time, it is highly recommended to increase monitoring – especially for those industry segments highly vulnerable – to assess the severity of impact by COVID-19 and how long the road to recovery might be. Deferring the receipt of this information during an economic downturn could expose the financial institution to unnecessary loss that could have potentially been managed through the problem loan management program. The current environment introduces an opportunity to strengthen this operational process and bring together your lenders and problem loan management team in an effort to assist borrowers and protect the financial institution.
In the next part of this series, we will continue the dialogue and focus on what financial analysis and frequent monitoring may tell you about a borrower’s performance and how to account for special considerations such as loan modifications and extraordinary items on financial statements.
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 further 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.
Our the previous two series of Problem Loan Management also available?