Problem Loans: Know Your Indicators for Prevention and Recovery

Banker Resource
January 15, 2013 — 2,433 views  
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Loans usually transit from closing to complete payout according to the loan terms without needing any serious collection effort. But sometimes, loans do not perform like they were expected to owing to numerous reasons. Financial factors usually contribute to commercial loans not performing like they should.

Other reasons that contribute to poor performance of loans include a bad economy, advances in technology, poor management, and competition.

Importance of Spotting Problems Early

In order to deal with problems with your loan, it is important to detect them early on. The sooner you can identify a potential problem loan, the higher your chances of recovery or even prevention of greater problems.

It is vital for the bank administration and lenders to work with each other to identify problem loans. Lenders are usually the best people to spot problems early on and should be given the main responsibility of doing the same.

Staying in close contact with the borrowers is the lender’s job and they should be able to consolidate financial information in a timely and accurate function. It is the job of a lender to find out problems much before they actually occur. 

Early Detection Facilitates Remediation

Only if you detect problem loans early on, can you find remedies to deal with the situation. The more time you take to resolve a problem, the harder the process will get. The main ways to remedy a problem include workout or rehabilitation, liquidation without the cooperation of the borrower, and liquidation with cooperation from the borrower.

For example, if an individual is using one credit card to pay another one, this shows that the person has exceeded his credit and is unable to pay. Another common occurrence is witnessed with mortgage payments. The borrower should have sufficient funds to pay for 6 months worth of living expenses in an account that is accessible in case of emergencies. Credit lines should not be used as a substitute.

Paying attention to those who have been defaulters in a mortgage payment will show that the loan is most likely to be a problem one later on.

Detecting Problem Loans

While you are making decisions, you might realize you are working with a borrower who is honest but is bogged down by too many debts. In such cases, there are several alternatives that could help evade a problem loan.

Reduce the debt by offering a discount for cash payments and moving the debt to a different bank, or even keeping it on your own books could help the situation. But there will be certain tax consequences which cannot be ignored.

Sell off the debt in a secondary market. A large number of firms specialize in buying loans that are not performing as expected at a good discount. Also, clearing houses are great as they help put sellers and buyers of distressed debt in contact, but all these methods are only useful if the problem loans are detected early on.

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