PROBLEM LOAN DETECTION: EARLY WARNING SIGNALS, STRESS SCENARIO ASSUMPTIONS, WHAT TO STAY ALERT FOR IN THE WAKE OF NEW CRISIS WAVE

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1 Regional Technical Workshop on Problem Loan Workout Techniques PROBLEM LOAN DETECTION: EARLY WARNING SIGNALS, STRESS SCENARIO ASSUMPTIONS, WHAT TO STAY ALERT FOR IN THE WAKE OF NEW CRISIS WAVE Delivered by: Leslie Sulenta Project Manager, Partners for Financial Stability Program Yerevan, Armenia December, 2012

2 2 Benefits of Early Identification Usually easier to deal with Potential for out placement

3 3 Prevention Written loan policies Thorough training of loan officers and support staff Control loan authorities and have clear loan approval procedures Loan Agreements (US) - Loan covenants

4 4 Prevention Take a close look at the borrower and his business prospects Understand the true complexity Document the loan to protect yourself Verify financial statements Verify liquidity

5 5 Prevention Complete and accurate documentation of credit information and collateral High performance standards and leadership Early identification of potential problem loans (Culture)

6 6 Prevention Continual analysis and assessment of updated financial information Verify information submitted Regular visits, particularly at his place of business open line of communication with borrower / company management

7 7 Challenges Some common issues/challenges banks have with customers: The money loaned to the customer often used for another purpose - usually to pay off a third party Once loan payment is delayed - often difficult to find the customer (they are sick, mothers are sick, they are travelling, etc) The postal service cannot be relied upon in - the bank will use its own employees to deliver registered letters to customers' place of employment

8 8 Financial Red Flags Failure to deliver financials in a timely manner Deterioration of financial condition Deterioration of liquidity (cash) Low equity, high level of debt Significant increase in debt Declines in sales Operating losses Increase in delinquent receivables

9 9 Financial Red Flags Increases in inventory levels Slowdown in inventory turnover

10 10 Red Flags - Company Management Inexperienced management Dishonesty Inexperience with product or service Poor strategy Poor planning Taking too many risks Lack of marketing Lack of vision Lack of training Lack of communication

11 11 Red Flags Company Management Over reliance on 1 or 2 suppliers / customers Unusual or creative accounting Failure to develop new products Frequent changes and personnel conflicts Excessive turnover Failure to train (succession)

12 12 Red Flags - Character Willingness to perform Integrity Attitude Avoidance Illness / death

13 Regional Technical Workshop on Problem Loan Workshop Techniques 13 Red Flags - Character Always "fighting fires" Inability to plan or budget Not reacting to changing conditions Entering new fields Inability to meet commitments

14 14 Red Flags - Character Changing bank relationships Change accountants Insurance cancellations Change in lifestyle by senior management Avoidance Adverse changes in behavior Litigation

15 15 Red Flags Missed loan payments Overdrafts Sudden unexpected losses Delay in receipt of financial information

16 16 Red Flags Poor maintenance on plant/equipment Prolonged Litigation Entering new fields Inability to meet commitments

17 17 Red Flags - Contractor / Developer Ineffective financial management system Bank lines of credit are evergreen Poor estimate and job cost reporting Poor project management/oversight No comprehensive business plan Communications problems Loss of loyal customers

18 18 Red Flags - Contractor / Developer Accounting & Financial Management Problems Changes in ownership and/or personnel Changes in business and/or over expansion Factors beyond a contractors control Construction loan management

19 19 Red Flags Within the Bank Loan generation at the expense of portfolio management Inadequate checks & balances Lack of accountability Unclear communication of policy All credits are managed alike Break downs in the credit process

20 20 Responsibility for Detection? discussion Loan Officer Division Head or Senior Loan Officer Loan Review Auditor Examiner

21 21 Responsibility for Handling? discussion Loan Officer Workout Officer Workout Team Accountant/Lawyer/Consultant Issues Opportunity Costs Negotiation Skills Lender Liability

22 22 Stress Testing for Early Detection Many supervisory authorities require banks to regularly conduct stress testing to assess: Their exposure against credit risk, by considering the possible changes in the future of risk factors which affect credit portfolio s quality and The bank s financial situation, materialized in net income and in capital adequacy ratio.

23 23 Stress Testing for Early Detection Discuss sample Stress Testing Worksheet.

24 24 What to Stay Alert For in the Wake of the New Wave of Crisis

25 25 Workshop Instructor. Leslie Sulenta Chief of Party Deloitte Consulting LLP David Cowles COTR USAID Rita Melhem Engagement Director Deloitte Consulting LLP

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