Loan Portfolio Assessment

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Chastity Haynes
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1 Loan Portfolio Assessment Programmatic success, measured to a certain extent by a program s charge-off rate, has a direct bearing on the level of interest demonstrated by funding partners. Accordingly, loss assessment significantly influences prospects for a loan program s long-term sustainability. The purpose of this technical assistance article is two-fold. The first is to present you with two loss assessment methods. The second is to provide you with a method to identify consumers that are in jeopardy of defaulting on their loans (Aging Report). Loss Assessment Methods There are two methods available to calculate and identify loss. The first method is called the principal method. The second is call the average accounts receivable method. 1. Principal Method The principal method compares the total principal amount of loans originated (funded) and the total principal amount of loans charged-off (less payments applied to accounts after the accounts are charged-off) during the life of a loan program. The resulting answer, reflected as a loss percentage, provides the program-to-date charge-off rate. Nationally, in order to obtain meaningful data, it is important for each loan program to evaluate loss in the same manner. With each loan program calculating loss in a consistent manner, a loan program can then gauge its performance against the following national benchmarks. The desired program to date charge-off rate is less than 15%. The desired charge-off rate for a program after its initial year of operation is 4%. The 4% benchmark is identified as the national benchmark as a result of the data provided by loan programs that demonstrated best practices. Actual national charge-off rate at a specific moment in time as compared to other programs with similar volume, demographics, loan portfolio size, staffing levels, and program longevity. Ways to Work, Inc West Lake Park Drive, Milwaukee, WI Phone (866) ; Fax: (414)

The first is to present you with two loss assessment methods. The second is to provide you with a method to identify consumers that are in jeopardy of defaulting on their loans (Aging Report).

2 Technical Assistance Memo #7 Loan Portfolio Assessment Page 2 The principal method for calculating a charge-off rate is as follows. Loans Originated Principal Method Calculation Identify the total principal dollar amount of loans originated (funded) beginning at the inception of the loan program and concluding on the current date. (Current date is the date you are computing the charge-off rate) Program Inception Current Date $100,000 Dollar Amount of Loans Funded Charge-Offs Identify the total principal dollar amount of loans charged-off. Begin at the inception of the program and conclude on the current date Program Inception Current Date $5,000 Principal Dollar Amount of Loans Charged-Off In accordance with the Ways to Work guidelines, loans that become past due are to be charged off no later than 120 cumulative days from the contractual due date. The charge-off action is to take place by the end of the month that the loans are charged-off. Payments on Charged-Off Accounts Identify total principal amount of payments posted to accounts after accounts are charged-off. $1000

(Current date is the date you are computing the charge-off rate) 10-01-96 Program Inception 11-24-98 Current Date $100,000 Dollar Amount of Loans Funded Charge-Offs Identify the total principal

3 Technical Assistance Memo #7 Loan Portfolio Assessment Page 3 Charge-Off Rate Divide the total principal amount of charged-off accounts (less the principal payments for charged-off accounts) by the total principal amount of loans originated. The resulting percentage charge-off rate. $5,000 (Charged-Off) Minus $1,000 (Payments Posted to Accounts After Accounts Are Charged-Off) = $4,000. $4,000 Divided By $100,000 = 4% 2. Average Accounts Receivable Method The average accounts receivable method compares outstanding loan balances (accounts receivable), including interest and late fees, with the total amount of charged-off dollars (less payments applied to accounts after they are chargedoff) for a specific time period. The resulting percentage is the charge-off rate for the reporting period. The average accounts receivable method identifies loss for a specific period of time. This is extremely important because it provides essential information used for the purpose of monitoring loss fluctuations or trends. The results obtained annually, semi-annually and quarterly have a bearing on the following loan program components. Loss reserve pool funding requirements Future program goals and objectives Acceptable level of risk policies for loan committees Collection strategies Case management strategies Caution should be paid to assessing loss on a monthly basis using the accounts receivable method. If there are excessive charge-offs during a specific month, then the charge-off rate can be overstated for that particular time period. The preferred method is to evaluate loss performance on a quarterly, semi-annual, and annual basis in order to assess loan portfolio performance. In accordance with Ways to Work guidelines, loans that become past due are to be charged off no later than 120 cumulative days from the contractual due date. The charge-off action is to take place by the end of the month that the loans are

4 Technical Assistance Memo #7 Loan Portfolio Assessment Page 4 charged-off. The method to assess loss using the average accounts receivable method is as follows. Average Accounts Receivable Method Calculation Identify Accounts Receivable (Balances Due on Loans) Identify the average accounts receivable amounts (the total balances due on loans, including interest and late fees) for the report period. Balance From 1/1/2000 $100,000 Through 12/31/2000 $ 80,000 Add Balances $100,000 plus $80,000 = $180,000 Determine Average Accounts Receivable Balance by Dividing Above Amount by Two (2) $180,000 Divided by Two Equals $90,000 Identify Charge-Offs Identify the total dollar amount of charge-offs (including interest and late fees) for the report period. From 1/1/2000 Through 12/31/2000 $6,000

interest and late fees) for the report period.

5 Technical Assistance Memo #7 Loan Portfolio Assessment Page 5 Identify the total dollar amount of payments received for charged-off accounts (payments posted to accounts after accounts are charged-off). From 1/1/2000 Through 12/31/2000 $500 Calculate Loss (Charge-Off Rate) Subtract the total amount of payments received on charged-off accounts from the total dollar amount of charged-off accounts. The result will be the net chargeoff dollars. $6,000 (Charged-Off) Minus $500 (Payments Received After Accounts Were Charged-Off) = $5,500 ( Net Charge-Off) Divide the net charge-off dollar amount by the average accounts receivable. The resulting percentage is the charge-off rate for the report period. From 1/1/2000 Through 12/31/2000 $5,500 Divided By $90,000 = 6.1% Aging Report Accounts 30 Days Past Due and Accounts 60 and 90 Days Delinquent Systematically reviewing consumers payment histories is fundamental to identifying the status of accounts and developing loss minimization strategies. The minimum requirement for reviewing payment histories is monthly. Active accounts are those accounts that reflect current payment histories for consumers. Accounts that exhibit missed payments are considered past due or delinquent. Definitions for these categories are as follows.

From 1/1/2000 Through 12/31/2000 $500 Calculate Loss (Charge-Off Rate) Subtract the total amount of payments received on charged-off accounts from the total dollar amount of charged-off accounts.

6 Technical Assistance Memo #7 Loan Portfolio Assessment Page 6 Past Due Status Accounts in which payments have not been posted for a time period of more than 30 days but less than or equal to 59 days cumulatively from the contractual due date. Delinquent Status (60 day and 90 day) 60 Day Delinquent Status Accounts in which payments have not been posted for a time period 60 days or more but less than or equal to 90 days cumulatively from the contractual due date. 90 Day Delinquent Status Accounts in which payments have not been posted for a time period of more than 90 days cumulatively from the contractual due date but have not been chargedoff. Degree of loss is determined to a great extent by the ability of the program operator (loan coordinator) to effectively develop and implement loss identification and collection techniques. The level of communication (quantity of and quality of) between a loan program operator and past due or delinquent status consumers drastically affects the ultimate degree of loss. Potential charge-offs are identifiable. Identifying potential charge-offs allows loan coordinators to minimize charge-offs. Payment histories identify the consumers who are either in potential jeopardy of or who are in imminent danger of defaulting on their loans. With that information available, the loan coordinator contacts consumers to identify payment obstacles and develop payment solutions. The job description for a program operator directs that he or she monitor payment histories and initiate contact with consumers to identify payment problems and develop payment solutions. Systematically monitoring payment histories and remaining in timely contact with consumers results in the following: Increased number of consumers develop positive payment histories. Increased number of loans paid in a timely manner. Increased number of loans paid in full. Losses minimized. Please contact Ways to Work at (866) or operations@waystowork.org with questions.

Delinquent Status (60 day and 90 day) 60 Day Delinquent Status Accounts in which payments have not been posted for a time period 60 days or more but less than or equal to 90 days 90 Day Delinquent

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