Problem Loan Management: Are You Being Effective?
Randall R. Doyle, CPA, MBA
Work-out and Business Turnaround Consultant
Houston, Texas
The Banking industry’s term for “Problem Loans” is aptly named. Problem commercial loans add to a bank’s legal costs, drain profits because of their loss reserves and write offs, distract management and staff from strategic priorities, and if significant to the bank’s bottom line, can demoralize the bank staff. The harsh reality is that problem loans have taken banks down. There is nothing good that can be said about them. Also, few people like the work problem loans create because it can mean dealing with the dishonest, the deadbeat, and getting in the middle of disputes and lawsuits. Finally, solving problem loans is complex work requiring a seasoned understanding of legal, financial, general business, banking, management, and people issues applied to many different industries. As a result, finding the unique skill set needed to effectively solve problem commercial loans can be difficult.
Because of its undesirable and complex nature, problem loan management is one of the trickiest areas of responsibility for the bank executive. “Certainly, it’s one of the most important to the bottom line where timely action and good management are critical,” says Merrill Reynolds of the Banker’s Edge in New Braunfels, TX whose bank consulting practice provides loan review, problem loan management, and other consulting services for financial institutions nationwide. “The early identification and management of problem loans significantly reduces the adverse impact of problem loans. Conversely, when left unattended, problem loans will drain a bank’s bottom line,” Reynolds said.
How does a bank executive know if the bank’s problem loan management practices are effective? Here are five questions that will guide you through your self assessment:
1. Are you providing timely and adequate support for your loan officers? Often loan officers need help to work through a problem loan. The main reason is that the loan officer is a marketer who can get too close to the borrower to be objective about the realities of the problems and expectations for recovery. How often have you heard a loan officer unrealistically assert that his troubled borrower’s liquidity crisis will be solved by its next big deal? Also, problem loans often require more time and attention than the bank officer has available. The problem loan gets put on the back burner in favor of working on the next loan which is a much more pleasant task. In spite of this, many banks prefer to keep all of their problem loan work with their loan officers. Reynolds said, “One of the most common mistakes I see bank executives make is not providing timely problem loan management assistance for the loan officer. Many loan officers do not have work out skills, especially for complex problem loans. Plus, the loan officer can become too emotionally connected with the borrower to be objective and realistic. When this happens, either the bank’s work out actions are delayed, or the root cause of the problem loan is not understood until it’s too late.” Reynolds added that “banks also suffer an opportunity cost because the loan officer has less time on business development when he/she is solving problem loans.”
Clearly, there are times when the problem loan can be worked out by the loan officer alone. There are other times when the loan officer needs the help of a work-out specialist who is not emotionally connected with the borrower to gather data, analyze the situation, create solutions, and negotiate with the borrower. Finally, there are times when the responsibility for the problem loan must be transferred completely to the work-out specialist without further involvement of the loan officer. As the bank executive, your answer to this question is critical in ensuring that you allocate the resources necessary for a timely and effective solution.
2. Are your work-out resources sufficient? The incidence of problem loans ebbs and flows with the economy and with the bank’s loan portfolio. Since nobody plans on having problem loans, it’s very difficult to plan the work-out resources. As a result, most banks find themselves in this difficult position when the number of problem loans exceeds the work-out resources. The bank’s risk of loss increases because the work out action is delayed due to the shortage in available resources. Therefore, the bank executive must periodically assess the adequacy of the available work-out resources and should have consulting relationships ready to address a short term need. Finally, the bank executive can be confident that an effective work-out function adds value beyond any incremental expense. A bank executive should expect a return of at least two times the investment.
3. Do you take a business approach to your problem loans? Banks generally have two approaches toward solving problem loans: one is legal and the other is business. The legal approach assigns the problem loan to the legal staff after minimal work- out resulting in foreclosure or other legal steps to protect the bank’s interests. The other response is a more comprehensive business approach that first determines the reasons for the business turmoil, assesses the viability of the business model, assesses the borrower’s managerial capacity to turn the business around, and weighs various financing solutions including new capital or debt financing. Integrated into the business approach is the work of the lawyers to ensure that the bank’s interests are protected, and that foreclosure is ready to be prosecuted if necessary. ’“Successful banks I work with have integrated their legal counsel into the special assets management function,” says Gentner Drummond, partner of the Drummond Law Firm that represents several banks in Tulsa, OK. “Under this model, the banker and lawyer work in tandem to maximize return and minimize loss and legal costs.” Drummond further said, “I am much more confident that the bank’s financial position will be better off when a business oriented solution is taken with a problem loan. I find that the most astute bank executive approaches most of his or her problem loans as business problems that require business solutions.”
4. Do my work-out people have the right competencies? In my 30 years of business experience, I have seen that the competencies of an effective work-out specialist are among the most complex. The work-out person must possess the rigid financial discipline of the CPA in one situation and have the creative imagination of a strategist in another. He must be both demanding and non-compromising with one borrower and compassionate and understanding with another. The work-out specialist must understand how businesses work, effectively negotiate, and have a solid working knowledge of banking, secured transactions, bankruptcy and finance. He must be able to size up people and management talent across a variety of situations. He must be creative and able to think outside the box to come up with alternatives that can salvage the business and improve the bank’s position. I suggest that your human resources staff create a competency model for your work-out staff or consultant. With your expectations defined for the position in hand, your likelihood of finding a highly competent person or consultant for this complex work will be significantly increased.
5. Is the bank’s financial position being optimized by the work-out plan? Each problem loan has multiple solutions that can produce different financial results for the bank. The effective approach to problem loan work-out couples creative problem solving with financial discipline to measure the outcome of each option. This ensures that each solution has been thought through completely and that its legal and financial consequences are understood. My experience is that unless at least three work-out options have been evaluated, it is unlikely that the work out plan optimizes the bank’s financial position.
Bank executives would do well to make problem loan management one of their bank’s core strategic organizational capabilities. By doing so, they assure that problem loans will get worked out faster, resulting in lower losses and costs. Further, the bank can take on a more aggressive growth strategy with the confidence that problem loans will be managed effectively, at minimal loss and minimal distraction to its loan officers.
Randy Doyle, CPA, MBA, is a work-out and business turnaround consultant with over 30 years professional business experience. He has served as the work-out executive for a independent bank; he has accomplished the turnaround of financially distressed businesses, served as consultant to independent businesses and in various financial management positions in large energy companies. Comments to this article can be made to Doylerr@aol.com.
© Randall Doyle Houston, Texas. February 22, 2006.
