Observations of a Workout Guy - Part 1
I often compare banks’ special mention and substandard commercial loan portfolios to lawns. Established lawns will thrive under excellent weather conditions. However, if a lawn is not periodically maintained or if there is a dry spell or a pest infestation, it will suffer. It may even require the engagement of a landscaping professional.
The same thing can happen when a problem loan portfolio is not actively managed or otherwise ignored. Criticized and classified loans by their very nature require attention, otherwise, they will linger or can become irreversibly worse. I will share some observations over the next few postings that I have made after working out over $100 million in problem loans during my career.
First, let’s start with current credit metrics. Amongst all U.S. banks, nonperforming loans (NPL’s) are down by 20% as of Q1 2018 compared to Q1 2016. The Top 5 loan types with the NPL category include 1-4 Family Junior Liens, 1-4 Family First Liens, Home Equity Loans, Farmland Loans and CRE (as defined by the 2006 Interagency Guidance). The reduction in banks’ OREO has surpassed this, registering a 42% decline.
Obviously, banks have cleaned up their balance sheets and the vast majority are enjoying very strong credit quality. However, we are in a small margin business, so when making a loan decision we need to be right 99%+/- of the time. With that said, we are also in the risk management game so there are always going to be a few “problem children” in our portfolios, even in this economy.
Red Flags: One of the main indicators of a borrower’s financial status is its payment performance. The best Chief Credit Officer I ever worked with tells his lenders, “Take your past due reports personally!” After all, they borrowed yourbank’s money and they signed a contract to pay it back in a timely basis. When borrowers don’t do this, they force the lender to explain to his/her superiors why they are not paying on the loan their lender recommended. More simply put, lenders should treat the funds they lend as if it’s their own money. This leads to enhanced collection efforts and usually better results.
“Red-Headed Stepchild”: Line lenders sometimes have to manage problem loans that were originally made by someone else. This often reduces a lender’s sense of responsibility towards these borrowers, and progress is slow/non-existent. However, to the bank, that does not matter. Regardless of where the original lender is now employed, the bank still owns that loan and needs to make sure the borrower satisfies its obligations.
Lender workflow/priorities: If you choose to direct your line lenders to service problems (or future problem loans), make sure they have the necessary tools and, most importantly, the support to work the loan. If loan goals are aggressive or internal resources are limited, then a resolution specialist (or landscaper in the lawn analogy), may become the best option to improve a bank’s asset quality metrics.