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3 COURSE OUTLINE Debt Portfolio Management Strategies for Debt Management Loan Monitoring and Control Early Warning Signals Loan Review and Evaluation Causes of Bad Debt Keys to success in Debt Portfolio Management Conclusion Question References

4 DEBT PORTFOLIO MANAGEMENT Bad debt portfolio can spell doom and trigger another credits crisis in the country. In the circumstances therefore, emphasis on lending ethics, credit control and administration is very important. Generally speaking, the declining economic fortunes of the country, coupled with dwindling market have significantly deteriorate credit quality. The result is that many lenders, knowingly or unknowingly are carrying bad or defective debts and have not adequately tested their credit risk management system. 3

5 DEBT PORTFOLIO MANAGEMENT In addition, most lending officers tend to underplay the importance of credit control and administration in their lending function because of the difficulties usually associated with it. In a volatile economy like Nigeria, it becomes imperative that control of lending must be exercised so that the lender is not caught off guard because of poor administrative control of its debt portfolio. 4

6 DEBT PORTFOLIO MANAGEMENT CONT’D A customer who is aware that he is not being monitored has every chance and temptation of diverting the original debt to riskier ventures that could cause the lenders a lot of harm. A businessman in a period of uncertainties lives more on his wits with an interest danger of overtrading; overstocking, unjustified expansion and diversification which could result in business catastrophes and consequently bad debts for the lender. 5

7 DEBT PORTFOLIO MANAGEMENT CONT’D If the increasing wave of bad debts now engulfing the economy is to be abated, these speculative tendencies on the part of customers and passive approach by lending officers towards credit control must be discouraged. 6

8 STRATEGIES FOR DEBT PORTFOLIO MANAGEMENT Like any management process, debt monitoring and supervision requires a process of action, analysis and follow-up. The following points are helpful in the debt supervision approach. 7

9 STRATEGIES FOR DEBT PORTFOLIO MANAGEMENT Lenders must operate within sound, well-defined facility granting criteria. These criteria should include a clear indication of the lender’s target market and a thorough understanding of the borrower, as well as the purpose and structure of the credit and its source of repayment. Lenders must receive sufficient information to enable a comprehensive assessment of the true risk profile of the borrower

10 In analysing facility, the following factors should be considered:  The purpose of the facility and sources of repayment  The current risk profile (including the nature and aggregate amount of risks) of the borrower and collateral and its sensitivity to economic and market developments.  The borrowers repayment history and current capacity to repay based on underlying transaction(s) dynamic, under scenarios  The borrowers business expertise and status of the borrowers economic sector and its position within that sector  The adequacy and enforceability of collateral or guarantees. STRATEGIES FOR DEBT PORTFOLIO MANAGEMENT Cont’d

11 Lenders should have in place a system for the ongoing administration of their various credit risk-bearing portfolios Once a facility is granted, it is the responsibility of the business unit, often in conjunction with a facility administration support team, to ensure that the facility is properly maintained. This includes keeping facility file up to date, obtaining current financial information, sending out renewal notices and preparing various documents such as debt agreements. It should also include current financial, internal rating documentation etc. STRATEGIES FOR DEBTPORTFOLIO MANAGEMENT Cont’d

12 Lenders should have information systems and analytical techniques that enables management to measure the credit inherent in all on- and off- balance sheet activities. The management information system should provide adequate information on the composition and quality of the portfolio. Lenders must have in place a system for monitoring the overall composition and quality of the debt portfolio. A continuing source of credit related problems is concentration within the debt portfolio. Concentration is in form of direct and indirect credit; a single counterparty, a group of connected parties, a particular industry or economic sector, a geographic zone, a types of credit facility, or a types of product. Lenders should periodically review economic or industry down turns, market risk event, liquidity condition STRATEGIES FOR DEBT PORTFOLIO MANAGEMENT Cont’d

13 Lenders must have a system in place for early remedial action on deteriorating credits, managing problem credits and similar workout situation Conditions of individual obligors must be reviewed periodically and proactive steps taken, when condition change negatively. A reduction in credit quality should be recognised at an early stage when there may be more options available for improving the credit Lenders must have a disciplined and vigorous remedial management process, triggered by specific events, that is administered through the credit administration and problem recognition systems Lenders must monitor borrowers and collateral values Debt analysts must recognise the business cycle effect when taking lending decisions. Some industries and businesses experience strong cyclical effects Lending officers must always ensure facility purpose as stated originally has not changed STRATEGIES FOR DEBT PORTFOLIO MANAGEMENT Cont’d

14 CONTROL THROUGH LOAN DISBURSEMENT AND OTHER DRAWDOWN CONDITION It is usual for the lender to plan some control measures over loan disbursements. This will ensure prudent management of financial resources and that loan objectives are optimally achieved. This is therefore often linked with cash flow cycle of the customer, hence an appropriate disbursement arrangement must be applied. For specific types, certain empirical disbursement criteria and consideration do apply. 13

15 SECURITY CONSIDERATION IN DISBURSEMENT I. Loan should not be disbursed until customer has satisfied all conditions. He is willing to comply in furnishing all necessary documentation but this is not always the case once he has taken the money. II. No disbursement should be allowed against anticipatory approvals. III. Disbursement can be made directly to the vendor or the supplier of goods and services. 14

16 LOAN MONITORING & CONTROL In many instance credit based on good judgment have turned bad not because the canons of lending were not adhered to but mainly due to poor administration and control of the facility. It then follows that for effective management of a sound debt portfolio, there is the need for accurate monitoring and proper documentation of the facilities. 15

17 LOAN MONITORING & CONTROL CONT’D  Acceptance of the terms and conditions of the loan on the copy of the letter of offer by customer. In case of a corporate borrower, a board resolution accepting the terms and pledging security to the banks is obtained.  Collection of all relevant documents required for the perfection of security. (Where applicable.) 16

18  Disbursement should be in accordance with the terms and conditions stipulated in the authorization letter.  When the facility is a loan, loan account is opened and debited with loan amount for the credit to customer’s account.  Authority to disburse a facility must come from loan administration after a thorough check must have been carried out by the department to ascertain that all conditions precedent to draw down have been met and all the necessary document are in place. 17 LOAN MONITORING & CONTROL CONT’D

19 Compliance with loan agreements, frequently agreements usually indicate minimum current ratios and liquidity ratios, that the borrowing company must maintain throughout the period of the loan. A deterioration will call for explanation. Without close monitoring a breach of the loan agreements may be undetected which could endanger the lender’s exposure. 18 LOAN PORTFOLIO MONITORING PROCESS Cont’d

20 CONTACT THE CUSTOMER - This is necessary for on the spot assessment of the operations of the business through visits. The rule is “Never wait until the customer comes to tell you to hear or know; go in search of what you desire to know”. 19

21 OPERATION OF ACCOUNTS - How a customer conducts his accounts should be of interest to the lender in general, the following situations should be watched:-  Nature of payments into the account  Discipline in customer’s account e.g. Frequency of excess requests, poor debts servicing etc. 20 LOAN PORTFOLIO MONITORING PROCESS Cont’d

22 EARLY WARNING SIGNALS (RETAIL) MACRO-ECONOMIC Large fiscal deficits High inflation and high nominal interest rates Changes in exchange rates Changes in tax rates Changes in income levels Changes in government policies 21

23 EARLY WARNING SIGNALS (contd.) BUSINESS FACTORS Lack of coherent business plan No niche Changes in business strategy Loss of market share Poor relations with Unions Increasing purchase to sales ratio Low inventory turnover, with high account activity High level of inventory despite contraction/low season Changes in mode of payments – cash to cheque or vice versa 22

24 EARLY WARNING SIGNALS (contd.) BUSINESS FACTORS Significantly higher growth than industry average Major litigation issue Sale of major assets Investment in unfamiliar business(es) Adverse relationship change with suppliers and customers 23

25 EARLY WARNING SIGNALS (contd.) INDUSTRY Weakening/dying industry Changes in regulation Technological change recognition Foreign competition Changes in customer preference Removal of entry barriers Sensitivity to economic cycles Changes in labour relation Industry in chaos/ consolidation 24

26 EARLY WARNING SIGNALS  MANAGEMENT  Change in behaviour and personal habit of key management staff.  Marital problem.  Change in attitude toward the lender (lack of co-operation).  Resurgence of problems presumed to have been Solved.  Inability to plan – lack of experience  Poor financial reporting and controls  Fragmented functions. 25

27 EARLY WARNING SIGNALS (contd.)  MANAGEMENT  Venturing into acquisition, new business, new Geographic area or new product line.  Desire and insistence to take business gambles taking undue risk (Speculation)  Unrealistic pricing of goods and services.  Failure to perform personal obligation.  Changes in management, ownership or key staff. 26

28 MANAGEMENT CONT’D  Illness or death of key personnel  Inability to meet commitments of profitable standard lines  Delay in reacting to declining markets or Economic conditions.  Lack of visible management succession.  One-man operations showing growth patterns that strain owner’s capacity to manage and control.  Change in business, economy or industry.  Labour problems – Excessive staff turnover 27

29 MANAGEMENT CONT’D Significant changes in ownership/ weak board Changes in key management Inaccessible/Evasive management Refusal to provide information Excessive “Life style” spending Unsubstantiated optimism 28

30 EARLY WARNING SIGNALS (contd.)  FINANCIAL FACTORS Deteriorating ratios and margins, high leverage Frequent changes in auditors or accounting policies Refusal of permission to speak with auditors Late submission of financials Sudden deviation from borrowing patterns Inability to clean up easily Requests for extension of maturities Evidence of other creditors refusing further extensions Covenant violations (ours or others) Inventory/receivables ageing Loss of asset value Adverse stock market reports 29

31 EARLY WARNING SIGNALS (contd.) Lender can pickup on these signals by: Understanding the industry and economic environment Staying close to the customer Understanding the customer’s business strategy Customer focus: internal organization Loans become problems when: Good judgment is not exercised at inception There are flaws in credit structuring Presence of Inadequate follow through/analysis Defective documentation Deterioration in borrower’s management or environment 30

32 LOAN REVIEW AND EVALUATION Loan review is monitoring control or control of advances. If lender fails to review their lending, they will quickly lose all money and be forced out of business. The function of lending and subsequent review of lending are complementary. Most commitments, once entered into are of a continuity nature and are likely to be reviewed monthly, quarterly and annually. Lenders must therefore maintain continuity in reviewing facility throughout the life of the commitment so that they will always be conversant with customers situation and so well placed to reach decisions at the proper time. 31

33 WHEN TO REVIEW LOANS A. Loan review generally take place under the following circumstances whenever new legislation is enacted or new regulations are imposed by the regulators affecting the established operations of a particular class of industry or commerce in which a borrowing customer is engaged. B. Whenever a vital information about a company or the class of industry or commerce in which it is engaged appears in the press or some publications 32

34 C. Before a personal contact with the customer whether the contact is by appointment or it is unannounced. D. Turnover should be reviewed daily when facilities are utilized. In some cases turnover covenant must be followed strictly E. Customers accounts should be reviewed yearly at the time of renewal of the facility. 33 WHEN TO REVIEW LOANS (CONT’D)

35 OBJECTIVES OF LOAN REVIEW A. To sport the danger sign as soon as possible. If a borrowing customer is getting into difficulties, it is possible for the lender to save the situation by timely advice. B. To give us insight into the workings of borrowing accounts as to whether the loan provider is getting its fair share of the business or not? 34

36 C. Un-authorized daily debit balances examine the print-out daily to ensure that accounts are operated within limits and authorized excesses have been reported and normalized promptly. D. Turnover should be reviewed quarterly to ascertain credits and debits as well as earnings. 35 OBJECTIVES OF LOAN REVIEW CONT’D

37 OBJECTIVES OF LOAN REVIEW ( CONT’D) Undertake a comprehensive quarterly review returns. This report should review at a glance the following positions.  Position of the account together with limits marked turnover within the period. Comparative turnover within the previous period.  Average debit and credit balances.  Earnings on the account.  Security held. 36

38 CONDITIONS FOR RECALL 1. Poor utilization of the facility 2. Improper conduct of the account 3. Development of a hardcore or evergreen trends 4. Failure to meet repayment schedule 5. Poor turnover. 37

39 CAUSES OF BAD DEBTS 1. Poor analysis of financial data 2. Quality of financial statements 3. Bad Judgment 4. Incomplete knowledge of customer’s activities 5. Bad management of the account 6. Inadequate project monitoring 7. Misrepresentation and dishonesty on the part of customers 8. Excessive lending on security values 9. Insensitivity of economic and environmental trends 10. Matters beyond customer’s control 11. Slow take-off 12. Inadequate funds 13. Inappropriate equipment and machinery 14. Raw material crisis 15. Loss of markets

40 KEYS TO SUCCESS IN DEBT PORTFOLIO MANAGEMENT The keys to successful Loan Portfolio Management out are: - I. Know the borrower II. Understand the business and managements way of conducting business III. Understand the economic realities IV. Know what you want, fix reasonable goals. V. Maintain alternatives - be flexible VI. Develop strategies with the cooperation of the borrower VII. Move fast VIII. Close monitoring. 39

41 MANAGEMENT OF PROBLEM LOANS PRUDENTIAL GUIDELINES CategoryClassificati on CharacteristicsRequired provision ActiveIPrincipal and/or interest repayments are made as follows and when due None SubstandardIIRepayment of principal and/or interest is in arrears for >90 < 180 days 10% DoubtfulIIIRepayment of principal and/or interest is in arrears for >90 < 180 days 50% LostIVNormal repayment of principal and/or interest is in arrears for >90 < 180 days 100%

42 CONCLUSION The aims and objective of debt management are critical and important with a view to managing the portfolio in a manner that is consistent with key pre-determined objective, designed to guard against any potential loss. The whole essence of debt portfolio management is to reduce risk rather than increasing return. Any lending organization must therefore develop efficient debt portfolio management which include effective credit extension, credit monitoring and excellent debt collection programmes

43 QUESTIONS I. Categorize and explain the regulatory directives with regard to the CBN prudential guidelines. II. How do you know that a company undergoing distress as the account officer. III. How would you identify a potential problem loan. IV. What are the critical success factors in managing a problem loan. V. Debt administration is a multilateral function explain what you understand by this assertion 42


45 REFERENCES & FURTHER READING 1. Branch Banking, Lending and Marketing, Personal course for Bankers written by P. GERRARD BSC, PhD, ACIB and E.P DOYLE, FCIB, MBIM, DIP Inv. Published by Northwick Publishers London in 1991 2. Branch Banking Lending & Marketing (Practise and Revision kit) Published by BPP Publishing Ltd, Aldine House, London in 1991 3. Lending Principles and Practice by S.A Talabi and A.T Onanuga published by Centre for Sandwich Programmes (CESAP) Olabisi Onabanjo University Ogun state 4. Strategic Approach to Bank Lending (Study Pack) for CIBN Professional Examination written by Solomon A Aderoju, FCIB, in 2001 5. Risk Management Techniques Training organised by the Lagos and District Society of the Institute of Chartered Accountants of Nigeria (ICAN) in Dec 15, 2008


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