ALM: Management of NPA

Sk. Nazibul Islam Faculty Member, BIBM

What is a problem loan?A loan to a borrower whose financial profile may deteriorate or where a payment schedule has been breached or where the banks secured position is likely to deteriorate.Any occurrence which may lead the bank to believe the loan has developed a higher risk then:such loans will be considered problem loans and treated accordingly.

What is NPA?A non-performing asset in the banking sector may be termed as an asset not contributing to the income of the bank. In other words, it is a zero-yield asset when applied particularly to loans and advances. The actual concept of NPA is that it is an asset which ceases to yield income for the bank and that any income accrued from such asset shall not be treated as income until it is actually realized.

Classification of an asset as NPA should be based on record of recovery.Therefore, an asset is to be classified as NPA when there is a threat of loss for the recoverability is in doubt. In spite of wide ranging reform measures initiated in the banking sector, the problem of non-performing assets assumed a central place in issues relating to banking sector.

NPA management must be thought of as an integral part of overall credit risk management.It implies that NPA management is not an independent event, that starts with the conversion of a performing loan into non-performing loan. In fact a robust NPA management must start before a loan becomes non-performing. It is much better to prevent an NPA, rather than curing or nursing an NPA.

Causes for growing Non-performing LoansImproper selection of borrowers, inadequacies of character, capacity and capital at the borrowers level. Inadequate information & improper investigationDeficiencies in appraisal, processing, sanction and release. Inadequate/excess sanction of the limit irrespective of the economic size of the unit.

Unrealistic terms or conditions of sanction and fixing unrealistic repayment schedule. Political interference in sanctioning of loans and patronage to defaulters. Lack of infrastructural facilities like power, raw materials, fuel, transportation, marketing and technical support. Lack of Inter-bank co-ordination as well as co-operation with financial institution in exchanging information over list of defaulters.

Defective security/shortfall in securities /collateralswrong structure of loan facilities(for example, loans were taken for industrial ventures but were used for speculative investment in the capital market)weak internal cash generation process in business leading to recurring past dues

lending on the basis of face value of borrowers without looking into their business fundamentals/or future potentialsIgnorance about the competitive market structureeconomic downturn in the developed countries as well as uncertainty in the market weak loan appraisal and limited capacity in understanding foreign exchange risks etc.

Willful default is a peculiar situation for the banks. The borrower earns sufficient income, generates adequate surplus but deliberately default in repayment of banks dues. Some of the glaring examples of willful default are: Utilization of loan to repay old debts due to the moneylenders friends and relatives etc. Utilization of loans towards real estate and gold etc.

Utilization of loan towards purchase of consumer durablesUtilization of loan towards marriage of sisters, daughters etc. Utilization of loan towards professional education of sons/daughters. The borrowers in the initial stage of availing loan run the business satisfactory and repay the installment timely. Once they earn the confidence the bank, subsequently avail large loans and refrain from paying back.

Business failure caused by over-expansionIrregularitySluggish marketDepressive economic situationMismanagementBad Investment

Financing in non-viable projects Saturated sectors Low rate of return Over invoicing Too high debt-equity ratio Faulty documentation

Consequences of NPA recycling of lendable resources are stoppedearnings are reducedcapital erosion happensloan pricing shoots upliquidity problem arise

What is a delinquent account?Any account in which the payment due has passed and the required payment has not been paid.

Example: If a loan payment is due on the last day of every month, it is delinquent on the first day of the succeeding month when the required installment is not paid.

Why does delinquency happen?There are two major factors which cause delinquency:UncontrollableControllableWhile some factors may be considered uncontrollable, the Bank can still mitigate their effects.

Uncontrollable FactorExample1. Natural calamities Typhoons, fires, drought 2. Government policies Crackdown on street vendors, increased taxes, relocation of public market 3. Loss of economically active members of the household Death, illness 4. Slowdown in the growth of local or national economy Increasing food prices 5. Low market price for farm products Over supply of fish

Controllable FactorExample1. Lack of clear-cut and consistent lending and collection policiesAbsence of collection proceduresAbsence of loan policies relating to loan information requirements, collateral, etc.2. Delinquency control is not a priorityThere is very little effort to collectBanks staff complacent in collectionSupervisory Board does not prioritize formulation of loan and collection policies

Controllable FactorExample3. Officers have insufficient knowledge, experience and skills in lending and collecting resulting in poor collection methodsCollectors or loan officers who prefer or are more suited to office-work types4. Lack of clear recordsNo aging reports5. Absence of incentives to good payers and absence or inadequate penalties for late paymentsDelinquent borrowers get repeat loans

Delinquent Loans

Provisions required

Early action can protect the bank rather than waiting

Delinquent borrowers-Collection tacticsStay calm. Never refuse to listen.Do not interrupt. Give the borrower a chance to explain.Show understanding. Let him know you can identify yourself with the situation.Try not to disagree with the customer.Respect the customers dignity and avoid embarrassment.

Identify the problem. Make sure you understand the situation.Find some solutions. Come up with a compromise.Keep smiling. Keep your mood positive.At the end of the meeting, ask the customer if he has any questions or concerns; andThank the customer for their time.

Management of Problem Loans

Prompt actionProblem loan reportInclusions in report

Management of Problem LoansAs soon as loan becomes a problem necessary to set up a collection process.Specify loan amount due and value of security associated with the loan.Write to customer under guidance of banks lawyers.Request interest/principal payment due, within a specified number of days.

Despite a prudent credit approval process, loans may still become troubled. Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the Banks interest.

Detection of Problem LoansMost common areas of upcoming problems:Declining salesDeteriorating ReceivablesInadequate cash flow (refer cash flow projections)Inventory turnover

Slowdown in the trade payablesIndustry problems (a slump or severe competition)A change in Management or ownership (may change direction of the business)Almost 60 items to watch for.

An Early Alert Account is one that has risks or potential weaknesses of a material nature requiring monitoring, supervision, or close attention by management. If these weaknesses are left uncorrected, they may result in deterioration of the repayment prospects for the asset or in the Banks credit position at some future date with a likely prospect of being downgraded or worse (Impaired status), within the next twelve months.Early identification, prompt reporting and proactive management of Early Alert Accounts are prime credit responsibilities of all Relationship Managers and must be undertaken on a continuous basis.

Management of Problem LoansArrange for a meeting (soft option) with customer, to establishif management is able to make loan repayment and if not then seeIf he/she is willing to proceed to a joint work out situation.one week to respond.if un successful in arranging meeting, then lawyers letter to issue to customer demanding repayment in full within a specified time frame.

Initial Loan Recovery Process

ProcessActionAmicable (Pre-legal)Aggressive (Pre-legal but with threat of legal action

Demand for payments (letter from lawyers)

Legal action ( in courts) 1. Phone call / personal visit (immediate upon default)Personal visit.(we may have to give this matter to our lawyers)Aggressive letter to borrower and guarantor (signed by legal counsel)Can take various forms:Demand for payments in arrearsLoan contract foreclosure (payment of arrears and future obligations and penalty)Collateral foreclosureExecution of guarantees

Borrowers AttitudeImportant to establish borrowers attitude to the repayment

PositionSolution1. Borrower cannot pay under any circumstances1. Foreclosure on collateral, charge off the remainder. 2. Borrower can pay, but with rescheduling/restructuring2. Reschedule/restructure following negotiation3. Borrower can pay but refuses to pay 3. Immediate legal action, collateral foreclosure, seizure of any other identifiable/available assets (of the business) or in the case of a guarantee personal assets.

Problem loans- Collection

Advise customer if failure to repay then under terms of mortgage it is your intention to sell the property upon court approval (if required), without further contact to customer.

Problem loans- Move to recovery DepartmentAt this point recovery department/unit become involved and again efforts are made to meet with customer and undertake a joint workout programme.Customer to be advised this is not necessarily a sell off.You are trying to help the company survive and reduce the bank debt at the same time.

Problem loans- Priority

Remember the priority at all times is to recover the debt.That is your job.Always remember that.

Problem loans- MethodologiesA very difficult experience with serious antagonism from within the business very likely.Important to get the companys team on your side-to work with you.Clearly they must realize you are trying to save their jobs and the business as well as trying to get the bank debt reduced to an acceptable level.

List AssetsAs soon as the loan comes under the jurisdiction of the recovery department, a list is made of all of the:- loans owing by the business to your bank and others- businesss assets short and long term. (balance sheet valuations)- business liabilitiesRevalue realistically the assets.

Work-Out ProceduresEstablishing Course of Action

Exercise strong legal collection Action

e.g. uncooperative professional avoiding payment commitments.Grant Payment Extension

e.g. professional person experiencing employment difficultiesRecommend write-off

e.g. customer is imprisoned or has left the country and is untraceableRestructure Deal, may include partial write off

e.g. low income customer experiencing high medical costs for treatment.

ReschedulingLoan scheduling 1st time:Avoid routine reschedulingExamine causes for reschedulingDown payment 15% of overdue installments or 10% of total amount of loan outstanding whichever is less.

2nd time rescheduling:30% of overdue installments or 20% of total loan outstanding whichever is less.3rd time rescheduling:50% of overdue installments or 30% of total amount outstanding.

Therefore, it is essential that early identification and prompt reporting of deteriorating credit signs be done to ensure swift action to protect the Banks interest.An account may be reclassified as a Regular Account from Early Alert Account status when the symptom, or symptoms, causing the Early Alert classification have been regularized or no longer exist. The concurrence of the CRM approval authority is required for conversion from Early Alert Account status to Regular Account status.

Corrective Measures:

- Legal Review of Docs & Situation- Workout Strategy & Action- Loss Evaluation vs. Security Cover- Stay or Leave Decision & Reclassification- Continuous Visits to the Client (Defaulter)- Negotiation vs. Court Action

Thank You