Regardless of how you describe 2020, change was the common theme.
Not only did the coronavirus pandemic and economic contaction in 2020 change the way the banking industy identifies problem loans, it changed the way it approaches them. As 2020 unfolded, CLA continued to encourage institutions to evaluate policies and procedures, given that most were written for normal operating environments. A problem loan is a credit that cannot be repaid according to the terms of the initial agreement, or in an otherwise acceptable manner. In a time when payment deferrals and modifications are numerous and widespread, and government-assisted credit is necessary, how does problem loans identification change?
The first step in problem loan management (PLM) is an effective risk identification program, which includes proper monitoring and continually applying appropriate risk ratings. Management teams can use internal reviews performed periodically or annually to assist with early risk detection.
Frequent monitoring of the portfolio remains one of the critical pillars of PLM. This requires collecting updated financials and information to monitor the wherewithal of the borrower, guarantor and related entities on a standalone and combined basis. Increased monitoring is warranted, especially for vulnerable industries.
Who leads your bank’s PLM program? Many lenders have not been exposed to a PLM process, or have not been in the industry long enough to experience an economic downturn. The art of PLM involves objective parties, including a group independent of the loan officer, to manage the loans effectively.
Evaluation of performance
Financials for 2020 will include unusual items, and completing year-over-year comparisons will require eliminating “extraordinary” items. For example, removing funds received through the Small Business Administration’s Paycheck Protection Program will be essential to ascertain and review the performance of core operations. Banks will need to consider how a borrower’s core performance would have met the requirements of the original loan terms without modifications. It is pertinent to remove these items and evaluate how the borrower is functioning at its core.
The routine nature of completing a quarterly problem loan action report deserves a new look. Banks of all sizes must address problem loans and develop plans to mitigate exposure. Action plans are a way for management to track and document each borrower’s circumstances and next steps to reduce credit risk exposure.
Problem Loan Action Plan Considerations
- Borrower identification and history — Identify the obligor(s) (direct and indirect), ownership composition, type of business, underlying debt(s), and operational changes over the past few years or as a result of COVID-19.
- Communication — If the borrower remains communicative, address commitments made, if any, and all legal correspondence.
- Financial analysis — Update financial information with a look at historical trend on standalone and global basis and impact of COVID-19.
- Repayment history — Review payment status, including any late payments or 30/60/90-day history. Discuss modifications.
- Collateral valuation and analysis — Evaluate need for updated values given changes in market, property type, or other pertinent factors.
- Risk rating — Consider current and recommended risk rating changes, if any.
- Impairment analysis — Clearly document the analysis or testing for impairment to support quarterly Allowance for Loan and Lease Losses analysis.
- Progress update — Address actionable items from the last review. Is workout plan effective?
- Next steps — Detail steps the borrower and institution will take to improve the status of the loan. Establish clear and quantifiable objectives and timeframes for both parties and document results as the plan progresses.
The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CliftonLarsonAllen) to the reader. For more information, visit CLAconnect.com.
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