Problem Loan Management

Participant Guide
November 2001

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Problem Loan Management

Course Description Loans that get into trouble bring both direct and indirect losses to the
banks. The purpose of this course is to examine the causes of the
problem loans and the procedures that can be instituted to manage them
effectively. Topics include corporate crisis situations, warning signals,
and policies that the bank can use to recover bad debts. Case studies
are used to highlight the points and issues brought out in the course.

Target Audience This seminar is designed for managers and senior-level officers
responsible for loan review and problem loan administration; bank legal
department staff and managers responsible for problem loan
documentation, workout situations, and receivership management.

Prerequisite Credit-related work experience highly desirable.

Course Topics This seminar covers a range of topics associated with problem loan
management, including:
♦ Introduction and Overview of Risk Management;
♦ Causes of Company Failure;
♦ Warning Signals;
♦ Financial Distress Characteristics;
♦ Predicting Business Failure;
♦ Cash Flow Analysis;
♦ The Bank and Workout Situations;
♦ General Recovery Strategies;
♦ Types of Recovery Situations;
♦ Characteristics of Successful Recovery Strategies;
♦ Valuing a Business in Liquidation; and
♦ Steps in Problem Loan Management.
 Unit 1 :
Overview and Objectives

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Ice Breaker

• What is your name?

• What is one interesting thing about your

professional experience?

• What are your expectations of this course?

OH 1-1
 Purpose

• Participants will discuss how to apply the key

elements of the Problem Loan Management
Course to their jobs.

Objectives

At the end of this unit, participants will be able:

1. Describe the objectives of problem loan

management and the framework guiding the
process.

OH 1-2
 .
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OH 1-3
 Problem Loan Recovery Process

Develop Recovery
Perform
Strategy
Recovery
Analysis
Exit
I Approve Execute
- Industry
D Recovery and
dynamics
E or Strategy Monitor
N - Financial
T condition
I - Management
F quality
Y
Restructure
- Security
realization

Establish Loan Loss Provisions

OH 1-4
 Problem Loan Management
Unit 1 Overview and Objectives

Unit 2 Problem Loan Identification

Unit 3 Recovery Analysis

Unit 4 Recovery Strategy

Unit 5 Recovery Strategy Approval

Unit 6 Strategy Execution and Monitoring

Unit 7 Case Study Discussion

Unit 8 Summary

OH 1-5
 Overview of Content Within Each Unit

• Unit 1 - Introduction to course

• Unit 2 - Identify problem loans and how to manage

transfer of problems loan

• Unit 3 - How to assess creditworthiness of problem

loans to determine recovery strategy

• Unit 4 - Outline how to formulate problem loan

recovery strategy and action plan to implement
strategy

• Unit 5 - How to prepare a recovery strategy

package and obtain approval of package

• Unit 6 - How to promptly identify and address

recovery problems

• Unit 7 - Discusses the case as developed in the

course

• Unit 8 - Summary of course

OH 1-6
 NOTES

Overview and Objectives PG 1-7

 NOTES

Overview and Objectives PG 1-8

 NOTES

Overview and Objectives PG 1-9

 NOTES

Overview and Objectives PG 1-10

 NOTES

Overview and Objectives PG 1-11

 Unit 2:
Problem Loan Identification

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Purpose

You will learn how to identify problem

loans early and how to manage the
problem loans.

Objectives

At the end of this unit, you will be able to:

1. Identify problem loans early.

2. Ensure problem loans are managed by

appropriate resources.

3. Ensure additional exposure incurred is

controlled to the advantage of the
bank.

OH 2-1
 Problem Loan Recovery Process

Develop Recovery
Perform
Strategy
Recovery
Analysis
Exit
I Approve Execute
- Industry
D Recovery and
dynamics
E or Strategy Monitor
N - Financial
T condition
I - Management
F quality
Y
Restructure
- Security
realization

Establish Loan Loss Provisions

OH 2-2
 Examples of
Warning Signs and Data Gathering

FOUNDATION WARNING SIGNS DATA REQUIRED

• Laws Change • Legislative notices

Industry
Dynamics • Increase competition • Price levels, list of new competitors

• Unable to meet • Payment status, Debt service ratio

Financial interest payment
Condition
• Poor account • Account fluctuation from branch
fluctuation

• Significant staff • Staff levels/new hiring

Management turnover
Quality
• Turnover of key • Executive rosters
executive/owners

Security • Decline in • Time required to execute security

Realization executability
• Inventory and A/R’s levels
• Decline in control

OH 2-3
 Monitoring Data Collection

Ability to service debt is a key measure of

creditworthiness.

• Key tangible way to measure liquidity and

financial condition

• May lead to weakness in other credit

foundations

- Industry Dynamics

- Financial Conditions

- Management Quality

- Security Realization

OH 2-4
 Required Actions for Non-Payment

Internal External

• Notify department • Call customer and

management request payment
within 7 days

• If not corrected • Increase monitoring

within 15 days, notify
credit committee and - Update creditor
downgrade calls
classification
- Increase
By law in Poland, customer calls
if not paid in 30 days,
reclassify - Check collateral

OH 2-5
 Customer Calls & Site Visits

Conduct customer calls and site visits to

obtain key data.

• Problems are often evident here first

• Problems are often disguised in financial

statements

Conduct customer call quarterly.

• Develop a call schedule plan

• Plan other necessary data gathering

OH 2-6
 Customer Classification Plan

A standard customer classification system:

• Identifies and isolates early warning signs

and triggers corrective action

• Prompts officers to draw conclusions

regarding creditworthiness

• Provides a basis for controlling and

managing the monitoring process

• Standardizes the measurement of risk and

creates a common language for addressing
credit issues

OH 2-7
 Standards for Classifying Loans

Classify loans based on a set of standard

guidelines.

Classification of credits is a subjective

exercise.

• Financial statements and tools can often

be misleading and inaccurate.

• Many required measurements are clearly

judgmental.

OH 2-8
 Classifications Definitions
Low Risk Relationships that represents minimal
risk, all credit components are strong
now in the foreseeable future

Acceptable Risk Relationships that represent

satisfactory risk with no material
weakness apparent

Moderate Risk Relationships where one or more

credit components are weak; although
no immediate loss is evident, close
monitoring is required

High Risk Relationships where material

weaknesses are evident and if not
corrected, repayment may be at a risk

Excessive Risk Relationships where impairment of

one or more credit components has
occurred and loss of principle or
interest is likely

Unacceptable Risk Relationships where a loss of principle

or interest is assured

OH 2-9
 Quarterly Review of Classifications

The review:

• Ensures the review encompasses a review

of debt service

• Makes it difficult to overlook this tangible

measurement tool

OH 2-10
 Credit Deterioration

If significant credit deterioration occurs

between quarterly reviews:

• Adjust classification

• Begin remedial action

Creditworthiness declines can occur at

anytime. For example:

• Regulatory changes

• Natural disasters

Prompt update of classification is critical to

controlling potential losses. It:

• Draws attention to a worsening situation

• Prompts corrective action

OH 2-11
 Remedial Action for High Risk or Worse

Place on a watchlist or other similar internal

list of potential problems and begin corrective
actions when companies are classified “high
risk.”

• The credit officer set specific strategies

and action plans to fix the weakness.

• Senior management is advised through

circulation of the watchlist.

Transfer to the problem loan department, if it

exists, companies downgraded to “excessive
risk” or “unacceptable risk.”

OH 2-12
 Changing Relationship Objectives

Relationship Management Recovery Management

Classification Ratings

1 2 3 4 5 6

Changing Objectives

• Increase business volume • Improve collateral

• Build strong personal • Control cash flows
relationships
• Obtain repayment
• Provide excellent service
• Control management
• Maximize value
• Minimize losses

OH 2-13
 Transfer Problem Loan

• Problem identified, bank’s objectives

change from relationship management to
recovery management.

• Recovery management requires

specialized skills.

• Transferring loan ensures early action is

taken.

OH 2-14
 Problem Loan Transfer Checklist

Items to Be Completed Date Transferring

Before Transfer Manager’s Initials

1) Change to problem loan

status

2) Customers files updated

3) Recovery officer
debriefed

4) Customer introduced

5) All Documentation
Transferred

OH 2-15
 Administering the Problem Loan

The bank should have standard operating

procedures for notifying branches of a customer
downgrade to Problem Borrower Status.

• Advice should go out to all branches through

most appropriate means.

• Pre-approval of how to apply payments should

be forwarded to relevant branches by the
Officer handling the problem loan.

• All operating transactions, including

application of overpayments, should be
referred to the Recovery Officer.

OH 2-16
 Discussion

• What types of problem loans have you seen?

• Do they tend to have recurring characteristics?

(such as similar industries, types of management,
etc.)

• What have you found to be helpful for getting the

greatest recovery on a problem loan?

• Participants who have a fully implemented

classification system, please give examples of how
it works.

• Participants who do not have a fully implemented

classifications system, please give examples of
the judgment criteria used.

• Give examples of how the transfer of the loan files

is implemented.

OH 2-17
 NOTES

Problem Loan Identification PG 2-18

 NOTES

Problem Loan Identification PG 2-19

 NOTES

Problem Loan Identification PG 2-20

 NOTES

Problem Loan Identification PG 2-21

 NOTES

Problem Loan Identification PG 2-22

 Unit 3:
Recovery Analysis

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Purpose

• Develop an in-depth evaluation of bank’s

position.

• Develop an effective recovery strategy.

Objectives

At the end of this unit, you will be able to:

1. Analyze the creditworthiness of the problem

relationship.

2. Formulate an appropriate strategy for

managing the problem relationship.

OH 3-1
 Problem Loan Recovery Process

Develop Recovery
Perform
Strategy
Recovery
Analysis
Exit
I Approve Execute
- Industry
D Recovery and
E
dynamics
or Strategy Monitor
N - Financial
T condition
I - Management
F quality
Y
Restructure
- Security
realization

Establish Loan Loss Provisions

OH 3-2
 Recovery Analysis

• Focuses on diagnosing specific credit

problems

• Seeks to develop an in depth evaluation of

back’s position

• Provides strong foundation to develop

effective recovery strategies

OH 3-3
 Recovery Analysis Process

Identify
Collect and verify data
Problem
Loans
Analyze credit
foundations

Measure risk exposure

and identify problems
Develop
Evaluate bank’s overall Recovery
position Strategy

OH 3-4
 Verify Data

• Verify data onsite

• Verify externally

• Data requests will over time, begin to change

the practices of the company

OH 3-5
 Roles of Bank Staff

• Recovery Inspector

• Technical Support -- for example, engineers or

real estate appraisers

• Administrative Assistants

OH 3-6
 Credit Foundations

Industry Dynamics

• Determines the nature of the industry

environment and the borrower’s position
within the industry

Financial Condition

• Determines borrower’s capacity to repay

through cash flow, collateral liquidation, or
other sources

OH 3-7
 Credit Foundations, continued

Management Quality

• Determines the integrity, competence, and

reputation of borrower’s management team

Security Realization

• Determines control of security and likely net

present value

OH 3-8
 Data Collection
FOUNDATION DATA REQUIRED DATA SOURCES

Industry • Industry profile -- 3 years • Internal

Dynamics - Size, growth - Files
- Concentrations - Research department
- Cyclicality/seasonality - Other managers familiar with industry
- Explanation of trends • Third parties
• Industry outlook - Ministries
• Profiles of key competitors (top two) - Multilateral agencies -- USAID, World
• Regulatory profile -- current, recent Bank, etc.
changes, expected changes - Other government organizations
• Borrower’s strategy - Trade associations
• Key alliances: - Other banks
- With government - Other companies in industries
- With private sector • External -- customer calls
- With other influential players • Library research and subscriptions

Financial • Company financials -- 3 years • Internal

Condition - Profit & loss statements, balance sheets - Files
- Supplementary statements -- reconciliation - Other managers familiar with borrower
of net worth, fixed assets • Borrower
- Audited where possible - In person calls
• Creditor facilities - Site visits
- Banks
- Suppliers
} amounts
facilities
and condition of

OH 3-9
 Data Collection, continued
FOUNDATION DATA REQUIRED DATA SOURCES

Financial • Additional company financial data: • Third parties

Condition... - Related company financials - Credit Bureau
Continued - Inter-group accounts - Creditors -- banks and suppliers
- Accounts receivable aging
- Explanation of key accounts --
investments, other assets/liabilities, etc.
• Financial projections
• Credit check -- at least 2 banks
Management • Background on all senior managers, • Internal
Quality including board members - File reviews
- Education, experience - Other managers
- Skills • Borrower
• Management’s track record - In person calls
- Performance - Manager interviews
- Information provided, meetings attended, - Site visits
other obligations • Third party
- Standing with other creditors - Government officials familiar with
• Alliances managers
- With government - Private sector individuals
- With private sector - Credit bureau
- With other influential players - Creditors -- banks and suppliers

OH 3-10
 Data Collection, continued
FOUNDATION DATA REQUIRED DATA SOURCES

Security • Security documentation • Internal

Realization - Titles and deeds - Files, vaults
- Insurance policies - Interview with managers
- Guarantees - Interview with lawyers
- Other documents - Case histories
• Legal opinion on executability • Borrower
• Physical verification - Site visits
• Assessed value - Calls
• Data base of similar cases • Third party
- Liquidation value of security vs. - Assessors
assessed value - Other lawyers
- Time to realize value - Creditors (concerning double pledging)
• Confirmation of bank’s seniority

OH 3-11
 Analysis Required in Central and Eastern
European Markets

• All credit problems must be identified and

assessed

• A full evaluation of the bank’s position is

required

OH 3-12
 Interactive Nature of the Foundations

• Problems in the Industry Dynamics may

weaken financial condition and security
realization e.g., when banking industries have
experienced deregulation and competition
increases causing reduced loan margins and
ultimately bank profitability

• Deteriorating financial condition may affect

security realization e.g., when a textile plant
was experiencing a weak cash flow, it
undertook inventory and receivable liquidation
to improve cash flow. This undermined the
bank’s security position.

OH 3-13
 Interactive Nature of the Foundations,
continued

• Poor management quality will have adverse

impact on the other three foundations e.g., if
management lacks proper skills and makes
poor business decisions, then ultimately

- Sales decline and profitability suffers

- The company’s position within the

industry declines

- Value of assets erodes, undermining the

bank’s security position

OH 3-14
 Industry Dynamics

Industry Environment Company Position

Market Industry Regulatory Competitive Potential Company

Cycle Structure Factors Position for Change Influence

OH 3-15
 Financial Condition

Profitability Liquidity Leverage

OH 3-16
 Management Quality

Integrity Competence Market Confidence

Honesty Cooperation Knowledge Skills Attitude Reputation Support

OH 3-17
 Security Realization

Control Net Liquidation Value

Documentation Executability Value at Time to

Liquidation Liquidate

OH 3-18
 First Foundation: Industry Dynamics

RISK AREA RATIONALE

• Structural problems in an industry can affect overall risk of

lending to an industry -- e.g., low returns, high costs, highly
Industry Environment competitive, etc.

• Environmental changes can have negative impact on lending --

e.g. trade impasses, FX deregulation, reduction in trade barriers,
etc.

Company Position • Competitive dynamics can put some companies at a critical

Within the Industry advantage or disadvantage

• Weakness in key areas required to succeed could affect overall

risk of lending

OH 3-19
 First Foundation: Industry Dynamics, continued
INDUSTRY ENVIRONMENT

COMPONENTS ANALYSIS PROBLEM AREAS (EXAMPLE)

Industry Cycle • Determine market size and growth during past • Shrinking market
5 years • Volatile market
• Assess why market is growing/declining • Dominant competitors forcing out smaller ones
• Determine how the market is segmented in • Key competitors have differentiated product with
terms of: strong loyalities
- Customers
- Geography
• Determine shares of leading competitors
and degree of concentration
• Assess other relevant factors
- Cyclicality
- Seasonality
Industry Structure • Evaluate industry characteristics and • Commodity like product leading to low profit
determine key features of each: margins
- Nature of products • Low barriers to entry resulting in overcapacity
- Barriers to entry/exit • Supply interruption
- Supplier power • Overreliance on few, weak suppliers
- Customers • Buyer concentration and power
- Substitute products - Large concentrations
- Standard and undifferentiated product
• Determine structural implications of industry - Low switching costs
characteristics (see facing exhibit) - Buyer
- Distribution channels • Certain competitors have locked up key
- Level of fixed costs and overcapacity distribution channels

OH 3-20
 First Foundation: Industry Dynamics, continued
INDUSTRY ATTRACTIVENESS

COMPONENTS ANALYSIS PROBLEM AREAS (EXAMPLE)

Regulatory • Review regulations which govern industry • Elimination of price controls leading to
Factors competition
• Review recent changes and determine
likelihood and nature of future changes • New players allowed to enter market

• Evaluate impact of recent and potential future • Additional risk exposure from deregulation of
changes on industry FX markets

• Price controls on key inputs lifted

OH 3-21
 First Foundation: Industry Dynamics, continued
COMPANY POSITION

COMPONENTS ANALYSIS PROBLEM AREAS (EXAMPLE)

Competitive • Identify key success factors -- what a • Company disadvantaged in critical areas and
Position company must do well to succeed -- based not able to compete
on industry attractiveness analysis
• Review competitors’ performance against
key success factors
• Review company’s performance against key
Competitors
• Rank company’s position

Potential for Change • Review company’s strategy • No strategy exists to address weaknesses/
• Assess in terms of: improve position
- Degree to which it addresses weaknesses/ • Strategy is not practical or achievable
Strengths
- Degree to which it addresses challenges/
Opportunities
- Management’s ability to execute
Company Influence • Review political affiliations • Company poorly positioned to lobby for
• Review private affiliations critical issues
• Assess implications for bank’s position and • Company aligned with unpopular or weak
company’s performance players

OH 3-22
 Example
INDUSTRY DYNAMICS Page 1 of 2
SUMMARY

Borrower: Vyroba Carpet Recovery Inspector:

Date Completed: March 20, 1999
Industry: Carpet manufacturing and export

Summary Overall Assessment: Level of Risk MR

Credit Problems:
• Signs of oversupply and reputation for quality declining in key markets
• Company fairly well positioned, but faces quality control problem which could weaken future position

Summary Analysis of Key Risk Areas:

Level of Risk Comments/Credit Problems
1. Industry Environment:
a. Market cycle MR • Market growth leveling
• Demand concentrated in German
b. Industry structure MR • Declining profit margins
• Low barriers to entry, increasing
c. Regulatory factors LR competition
• Favorable change in FX regulations
Overall: MR

OH 3-23
 Example
INDUSTRY DYNAMICS Page 2 of 2
SUMMARY

2. Company Position Within Industry: Overall Risk: MR

a. Key success Factors: Level of Risk Comments/Credit Problems

Access to low cost wool LR • Diversified sources of wool supply

Low cost labor MR • Labor demanding higher wages

Differentiated product HR • Follows market trend

Quality reputation HR • Inconsistent quality of product

Diverse range of buyers LR • Several large German, French buyers

b. Summary of Company’s Approach: Level of risk: MR Comments/Credit Problems

• Will hire new designer to develop differentiated product line • Strategy does not fully address
weaknesses
• However, no plan to address quality control line

c. Company Influence: Level of risk: Comments/Credit Problems

• Well connected with key politicians and LR None

private sector players

OH 3-24
 Sample
Classifications Definitions
Low Risk Relationships that represent minimal risk,
all credit components are strong now in the
foreseeable future

Acceptable Risk Relationships that represent satisfactory risk

with no material weakness apparent

Moderate Risk Relationships where one or more credit

components are weak; although no
immediate loss is evident, close monitoring
is required

High Risk Relationships where material weaknesses

are evident and if not corrected, repayment
may be at a risk

Excessive Risk Relationships where impairment of one or

more credit components has occurred and
loss of principle or interest is likely

Unacceptable Risk Relationships where a loss of principle or

interest is assured

OH 3-25
 Vyroba Carpet Industry Dynamics Ratings

RATING INDUSTRY DYNAMICS RISK AREAS COMPANY POSITION

Excessive and • Shrinking market; highly cyclical and concentrated • Company severely disadvantaged
Unacceptable Risk • Severe structural problems • No strategy
• Unfavorable regulatory environment • Alliances impair market position

High Risk • No market growth, cyclical and concentrated • Weak against all key success factors
• Unattractive structure • Poor strategy
• Worsening regulatory environment • Alliances weaken position

Moderate Risk • Slowing growth, signs of increasing cyclicality • Slightly disadvantaged against key success
• Emerging structural concerns factors
• Neutral regulatory environment • Strategy only partially addresses weaknesses
• Neutral alliances

Low and Acceptable • Growing, attractive market • Well positioned

Risk • Attractive structure • Practical, achievable strategy
• Favorable regulatory environment; no expected • Favorable alliances
Change

OH 3-26
 Second Foundation: Financial Condition

RISK AREA RATIONALE

• Indicates operating success, growth potential and competitive

Profitability position

• Often misrepresented and therefore must be scrutinized very closely

Liquidity • Determines ability to meet obligations -- operating expenses, debt

service, supplies credit, etc.

• Determines degree of financial risk and ability to absorb business risk

Leverage
• Is a sign of owners’ commitment to the business

OH 3-27
 Second Foundation: Financial Condition, continued
RISK AREA STRENGTH ANALYSIS PROBLEM AREAS
MEASURES (EXAMPLE)

Profitability • Financial ratios: • Complete financial spreads • Declining revenue

- Return on assets • Verify profitability • Increasing costs
- Return on sales information and determine - Payroll
- Return on equity credibility - Financing
- Operating profit/sales • Perform trend analysis - Cost of goods
- Admin cost/sales • Compare figures with other • Insufficient profits to support
- Etc. companies in industry growth
• Profit and loss statement • Perform site visits to assess • Insufficient scale -- excess
analysis inventory and fixed asset fixed costs
• Inventory quality quality • Insufficient inventory to meet
• Fixed asset quality demand
• Outdated production
• Insufficient skilled labor

Liquidity • Financial ratios: • Same as above • Poor quality current assets

- Current • Evaluate integrity of creditor • Illiquid investments
- Quick support • Non-productive fixed assets
- Working capital/assets • Evaluate current asset • Withdrawal of creditor
- Inventory turnover quality and aging of support
- Accounts receivable days on receivables
hand

OH 3-28
 Second Foundation: Financial Condition, continued
RISK AREA STRENGTH ANALYSIS PROBLEM AREAS
MEASURES (EXAMPLE)

Liquidity...cont’d • Financial ratios...cont’d • Assess shareholders’ support • Withdrawal of shareholder

- Interest/Operating profit - Willingness to guarantee support
- Etc. - Willingness to inject • High cost borrowings/
• Cash flow: additional capital bunching of payments
- Debt service • Review cost structure • High payroll/material costs
- Sources funds analysis • Develop debt service profile • Large investment costs
- Uses funds analysis • Review investment budget • Diversion of funds to
• Lines of credit • Review intra-group accounts associated companies/
- Bankers - Consolidating statements transfer pricing
- Suppliers - Receivables and payables to
related companies
- Prices to related companies
- Dividend payments
- Owners’ salaries/payment
Leverage • Financial ratios • Same as under Performance • Withdrawal of support
- Debt/Equity • Assess quality of reserve • High cost borrowings/
- Debt structure accounts bunching of payments
• Rate sensitivity • Reconcile net worth and verify • Overvalued equity
• Evaluate capital structure • Inappropriate capital
• Assess creditor/shareholder structure
support • Oversensitivity to interest
• Perform rate sensitivity rate swings
analysis under varying rate
scenarios

OH 3-29
 Example
FINANCIAL CONDITION SUMMARY Page 1 of 2

Borrower : Vyroba Recovery Inspector:

Date Most Recent Financial Statements : February, 1998 Date Completed : March 20, 1999
Period Covered : 1998 - 1999 Number Years Information Analyzed: 4
Audited : Yes X No Reliability of Financials:
Very Reliable X Reliable Unreliable

Overall Financial Condition Level of Risk: ER

Credit Problems:
• Increased leverage to finance recent plant expansion has adversely impacted performance, leverage, and liquidity
• Large inventory build up from inability to sell increased product further impaired all aspects of financial condition
Summary Analysis of Key Risk Areas:

1. Profitability Level Of Risk: ER % Net Income/Sales: (4%)

Credit Problems/Comments:

• Profitability reporting is fairly reliable

• Rapidly rising administrative costs -- from 5% of sales to 10% over past 3 years
• Increasing interest expense associated with financing of plant expansion (4% - 8% of sales)
• High depreciation costs (2% - 4% of sales)

OH 3-30
 Example
FINANCIAL CONDITION Page 2 of 2
SUMMARY

2. Liquidity Level of Risk: ER Net Operating Income/Debt Service: 0.75

Credit Problems/Comments: Current Assets/Current Liabilities: 0.8

• Increased debt service associated with debt financing of new plant

• Large inventory build up associated with inability to sell product from increased production
• Short term financing used to finance fixed assets

3. Leverage Level of Risk: Debt/Equity: 4

Credit Problems: ER Debt/Tangible Net Worth: 5

• Large loan recently taken on to finance plant expansion

• Owners were unwilling to inject more capital
• Losses have exceeded capital

OH 3-31
 Vyroba Carpet Financial Condition Ratings
RATING PERFORMANCE LIQUIDITY LEVERAGE
Excessive Risk & • Negative ratios, declining trend • Debt/Service below 1 • Debt/Tangible Net Worth >5
Unacceptable Risk • Increasing cost ratio, declining • Current ratios below 0.75 • Owners not willing to inject
revenue ratios • Declining trend equity
• Well below industry average • Large amount of short-term
debt supporting fixed assets
High Risk • Profit ratios probably negative • Debt/Service well below 1 • Debt/Tangible Net Worth 3 - 5
• Flat trend • Current ratios below 0.75 - 1 • Owners not willing to inject
• Cost ratios high, but not • Flat trend equity
Increasing • Below industry • Short term debt financing fixed
assets
Medium Risk • Profit ratios positive, but • Debt/Service above 1.5 • Debt/Tangible Net Worth 2-3
Declining • Current ratios above 1 • Owners willing to provide
• Costs increasing • Declining trend limited support
• Below industry average • Below industry average • Start term debt financing fixed
working capital
Low Risk & • Positive ratios, well above • Debt/Service above 2 • Debt/Tangible Net Worth below
Acceptable Risk industry average • Strong current ratio 2
• Flat increasing trend • Above industry average • Strong owner support
• Appropriate capital structure

OH 3-32
 Third Foundation: Management Quality
RISK AREA RATIONALE

• Forms the whole basis for a sound banking relationship

Integrity • Lack of integrity leads to:

- Inability to assess risk
- Inability to negotiate and reach sound agreements
- Lack of confidence in application of bank funds

• Incompetent management has little chance of addressing and resolving credit

problems to restore creditworthiness
Competence
• Poor management judgment leads to credit problems and failures

• Reputation will influence management/bank power balance and could make

it difficult to approach and negotiate with management
Market Confidence
• If management’s reputation is strong, the company may be better off to
survive a crisis

OH 3-33
 Third Foundation: Management Quality, continued
RISK AREA STRENGTH ANALYSIS PROBLEM AREAS
MEASURES (EXAMPLE)
Integrity • Honesty • Review credit files • Quality/reliability of
- Quality/Reliability of - Note missing information/ information
information documentation - Failure to disclose
- Meeting commitments - Frequency/nature of - Misrepresentation
- Character and track record communication - Inconsistent information
- Changing auditors
• Cooperativeness • Interview branch/regional - Refusing audits
- Consistency and quality of managers familiar with customer
communication with bank • Meeting commitments
- Supportiveness • Interview management - Failure to meet with bank
- Test openness - Failure to meet contractual
- Ask for references obligations
- Develop impressions - Failure to provide
documentation
• Interview government/private - Double pledging security
sector individuals familiar with
management • Character
- Obsessive tax avoidance
• Interview auditors - Involved in questionable
activities
• Compare information with other - Poor reputation
creditors
• Communication
- Postponing meetings

• Supportiveness
- Will not provide information
- Will not pledge security

OH 3-34
 Third Foundation: Management Quality, continued
RISK AREA STRENGTH ANALYSIS PROBLEM AREAS
MEASURES (EXAMPLE)

Competence • Ability • Interview branch/region manager • Experience

- Experience • Interview management - Lack of relevant experience
- Operating skills • Obtain key managers’ curriculums - Inability to manage
- Financial skills and determine: • Skills
- Administrative skills - Education - Insufficient skills to manage
- Management structure - Experience key areas
- Management depth - Related skills • Management structure
• Competence • Review performance - Biased board
- Decision-making track - Profits, growth, direction of trends - Lack of key functions
record - Compared with other companies - Lack of depth
- Risk profile • Review organization chart • Decision-making
- Determine span of control - Autocratic style
- Ensure all functions present - Lack of MIS/analysis
• Interview private sector/ - Unwilling to make difficult
government individuals familiar decisions (cost cutting, etc.)
with management - Risk profile
• Review risk profile - investments, - High risk investments
projects, debt/leverage
• Compare impressions with other
creditors
Market • Reputation • Interviews • Management disliked by
Confidence • Support • Time in business competitors who may spread
• Group memberships rumors
• Out of favor politically
• Poor reputation

OH 3-35
 Example
MANAGEMENT QUALITY SUMMARY Page 1 of 2

Borrower: Vyroba Recovery Inspector

General Manager: R.J. Tapa Date Prepared: March 20, 1999
Principal Shareholder: P.R. Pande % Company Owned: 80%

Overall Management Quality Level of Risk: MR

Credit Problems/Comments:

• Missing financial controller

• Competence questioned by recent decision to expand and increase leverage
• Otherwise, high integrity and favorable alliances

Summary Key Risk Areas:

1. Integrity Level of Risk: LR (Honesty, Cooperativeness)

Credit Problems/Comments:

• Management quick to provide any information requested

• Consistently meet obligations
• Very cooperative and open

OH 3-36
 Example

2. Competence Level of Risk: (Ability -- Experience, Skills, Depth;

Credit Problems/Comments: Competence -- Decision-making, MIS Profile)

3. Market Confidence (Affiliations, Lobbying Power, Power Balance vs. Bank)

Level of Risk: Credit Problems/
Comments

OH 3-37
 Vyroba Carpet Management Quality Ratings
RATING INTEGRITY COMPETENCE MARKET CONFIDENCE
Excessive & • Never meets commitments • No relevant experience/skills • Allied against current
Unacceptable • Poor quality, unreliable • No vision Administration
Risk Information • No depth • Poor reputation causing loss of
• Refuses to support relationship • Inappropriate organization Credit
structure
• Aggressive risk taker
High Risk • Rarely meets commitments • Limited experience/skills • Recent problems diminishing
• Information is of low quality, low • Limited vision Reputation
Reliability • Limited depth
• Weak relationship support • Poor structure
• Risk taker
Medium Risk • Generally meets commitments • Moderate experience/skills • Neutral reputation
• Reasonable quality information, • Moderate depth
generally reliable • Some vision
• Supports relationship • Adequate structure
• Risk neutral
Low & • Always meets commitments • Experience/skilled • Strong reputation
Acceptable • Quality, reliable information • Visionary
Risk • Strong relationship support • Deep management team
• Good structure
• Risk adverse

OH 3-38
 Fourth Foundation: Security Realization
SECURITY REALIZATION
RISK AREA RATIONALE

• Without proper documentation the bank has no claim on security

Control
• Without ability to execute claim, security cannot be realized

• Low liquidation values may not cover outstanding debts

Net Liquidation Value
• High liquidation costs will reduce net amount received

• Security quality may deteriorate over time

• Money has time value

OH 3-39
 Fourth Foundation: Security Realization, continued

RISK AREA STRENGTH MEASURES ANALYSIS PROBLEM AREAS (EXAMPLE)

Control • Perfection • Verify documentation • Legal rights
- Legal rights - Security perfection - Land title not pledged
- Documentation adequacy - Documentation completeness - Bank has second priority or is
- Double pledged security - Documentation integrity Subordinated
- Fraud - Insurance policy and • Documentation adequacy
- Insurance policy documentation - Lacking notary
• Executability • Assess customer’s lobbying - Missing signatures
- Ability to obtain favorable power with legal authorities, - Incomplete documentation
Judgment local potential buyers - Lacking stamp duty
- Ability to take possession • Conduct site visit(s) to verify - Outdated, past due
- Length of legal process security existence • Fraud
• Review recent trends in legal - Criminal proceedings
execution • Insurance does not cover
• Assess length of time to Exposure
complete legal action • Ability to obtain favorable
Judgment
- Customer has strong lobbying
Power
- Judge sympathetic towards
Customer
• Ability to take possession
- Missing security
- Difficulty in evicting squatters
- Security transferred
- Security immobile
• Length of legal process
- Documentation difficulties
- Lobbying conflicts
- Slowness of due process

OH 3-40
 Fourth Foundation: Security Realization, continued
RISK AREA STRENGTH MEASURES ANALYSIS PROBLEM AREAS (EXAMPLE)

Net Liquidation • Liquidation value • Use assessor to value security • Security is of poor quality or
Value - Quality - Quality & quantity Perishable
- Quantity - Market demand • Quantity not sufficient to cover
• Time of sale • Review recent cases Exposure
- Market price dynamics - Assessed value vs. sale value • Market demand
- Opportunity cost - Change in sale value - No market for goods
- Technology replacement - Time to sell - Security highly specialized
- Long legal process • Review economic conditions - Value too large -- few can
• Determine overall likely length afford
of sale - Borrower has influence over
- Auction process potential buyers
- Auction success/failure - Collusion against bank
- Sale on secondary market • Market price dynamics
• Select appropriate discount rate - Volatility
• Determine Net Liquidation - Inflation
Value - Rapid depreciation
• Opportunity cost – value
increases/decreases over time
• Technology -- security becomes
Obsolete
• Legal process
- Erodes security value
- Market could change during
Process

OH 3-41
 Example
SECURITY REALIZATION SUMMARY- CONTROL
Borrower: Vyroba Carpets Recovery Inspector:
Date Prepared: March 28, 1999
Assessor: Name: A. Murray Date of Assessment: January 10, 1999
FDM: Engineer Experts

Security Realization Level of Risk ER

Security Coverage:
• Control: Security perfected and adequate executability Credit Problems:
• Net Liquidation Value (000’s) : 524 Cedi
(Primary + Secondary Security) • Reduced liquidation value of
• Exposure (000’s): 2,500 Cedi machinery due to uncertainty
• % NPV/Exposure: 20% regarding carpet market
(Security Cover) • Real estate market uncertainty and
long lead time of sale reduces
security value

Summary Key Areas: Date Last Site Visit : February 10,1998

Credit Problems/Comments: Date Security Doc. Checklist:
1. Control Level of Risk: LR December 20,1997

a. Perfection: • All documentation perfected and in place

• Bank has senior claim on all security

b. Executability: • Customer not likely to lobby in case of liquidation

• Security can be easily transferred
• Potential for court delays in obtaining secondary security, but not expected to be
excessive

OH 3-42
 Example
SECURITY REALIZATION SUMMARY - NET LIQUIDATION VALUE

2. Net Liquidation Value Level of Risk ER (Cedi 000)

Total

a. Category of Security Building & Marketing Land - N.A.

b. Assessed liquidation value 1,500 600 - 2,100

c. Liquidation Value Discount 35% 32% - N.A.

d. Time of Sale 2 3 - N.A.

(Number of years)

e. Discount Rate (%) 15% 15% - 15%

(1 year fixed deposit rate+4%)

f. Discount factor 76% 65% - N.A.

(l/(l + e) d

g. Net Liquidation Value 399 125 - 524

(b x c x f)

h. Exposure (principle+interest) - - - 2,500

i. % NPV/Exposure -- Security - - - 20%

Cover (g/h)

OH 3-43
 Vyroba Carpet Security Realization Ratings

RATING CONTROL NET LIQUIDATION VALUE

Excessive Risk • Security not perfected • Security cover below 50%
& Unacceptable • Executability severely impaired
Risk
High Risk • Perfection is weak • Security cover 50% - 75%
• Executability complex

Medium Risk • Perfection adequate • Security cover 75% - 100%

• Potential executability issues

Low Risk & • Strong perfection • Security cover above 100%

Acceptable Risk • No executability complications

OH 3-44
 Step 4: Evaluate Overall Position

• Assess the combined impact of the risks

• Review for level of risk and credit problems in

each foundation

• Look for common problems across

foundations

• Look for how problems interact

• Reviewing combined impact provides a full

understanding of overall risk

• The analysis will also facilitate strategy

development

- Can creditworthiness be restored?

- Is exit or structure appropriate?

- Supports development of an action plan?

OH 3-45
 Example
SUMMARY RISK ASSESSMENT

Borrower: Vyroba Carpet Recovery Inspector:

Date Prepared: March 20, 1998

Summary Overall Position: Level Risk ER

List most salient credit problems and indicate symptoms in each pillar and trace cause/effect relationships

Credit Foundation: Industry Financial Condition Management Quality Security Realization

Dynamics

Level Risk: MR ER MR ER

Credit Problems: • Decreased leverage • Brings into operation • New plant may be
• Aggressive expansion - • Reduce profitability competence difficult to
financed by debt • Lower liquidity • Shows evidence of liquidate
high risk taker

• Growing overcapacity • Over- • Decreased inventory • Lower value or

and concerns competitiveness • Increased leverage- security
regarding product • Overcapacity need to finance working -
quality capital

OH 3-46
 Discussion

1. What are two objectives of recovery analysis?

2. What are the four creditworthiness

foundations to be analyzed?

3. In CEE, what may be the primary focus areas?

4. What the three risk areas of financial condition

that should be analyzed?

5. Once each credit foundation has been

analyzed, what is the key next step?

OH 3-47
 Summary

• After problem loan is identified, you:

- Conduct a recovery analysis

- Formulate a management strategy

• The four credit foundations are:

- Industry Dynamics

- Financial Condition

- Management Quality

- Security Realization

OH 3-48
 NOTES

Recovery Analysis PG 3-49

 NOTES

Recovery Analysis PG 3-50

 NOTES

Recovery Analysis PG 3-51

 NOTES

Recovery Analysis PG 3-52

 NOTES

Recovery Analysis PG 3-53

 Unit 4 :
Strategy Development

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Problem Loan Recovery Process

Perform Develop
Recovery Recovery
I Analysis Strategy
D EXIT
- Industry Approve Execute
E dynamics or
N - Financial Recovery and
T condition RESTRUCTURE Strategy Monitor
- Management
I quality
F - Security
Y realization

Establish Loan Loss Provisions

OH 4-1
 Objectives

At the end of this unit, you will be able to:

1. Define the process required to make

appropriate strategy decisions.

2. Conduct the analysis needed to make

appropriate strategy decisions.

3. Formulate action plans to carry out the

decisions.

OH 4-2
 Strategy Development

Strategy development has the primary objective of

maximizing recoveries through development of
appropriate action plans.

• The recovery analysis determined the type and

severity of the problem.

• The strategy development determined the

appropriate response.

OH 4-3
 Major Decisions of the
Strategy Development Process

• Can the overall creditworthiness be

restored?

• Should we exit or restructure?

• What is the best approach within the

selected exit or restructure course?

OH 4-4
 Recovery Strategy Framework

Can creditworthiness
be restored?

YES NO

Restructure
Net Liquidation Value (NLV)
Exceeds EXITS NLV

YES NO
EXIT
Restructure

OH 4-5
 Can the overall creditworthiness be restored?

• If creditworthiness cannot be restored, an exit

strategy is the required course.

• If creditworthiness can be restored,

restructuring may be the required course.

OH 4-6
 Process For Determining Restoration of Creditworthiness
Foundation Risk Area Problem Method of Likelihood of a Fix
Fixing
Identify Identify Understand Determine Estimate Likelihood
Weak Problem Risk the Method of
Foundations Areas Individual Fixing
Associated Elements and
with the Sources
Weak
Foundation

Industry Industry Market Obtain Unlikely Fix

Dynamics Environment Structure Government - Industry in decline
Protection of cycle
Industry Product substitution
has occurred
- Government more
market oriented

OH 4-7
 Some Generic Fix Strategies
INDUSTRY FINANCIAL MANAGEMENT SECURITY
DYNAMICS CONDITIONS QUALITY REALIZATION

• Diversify business • Restructure operations • Restructure Management • Restructure security

- Expenditure cuts - Replace - Perfect security
• Improve competitive - Reduce investments - Impose outside consultants - Obtain additional
position - Change pricing - Reorganize security
- Strengthen key
weaknesses e.g., replace • Liquidate assets • Restructure credit agreements • Liquidate security
management - Sell inventory - Require outside audits - Sell security with
- Revise strategy - Collect A/Rs - Impose performance/ highest Net Liquidation
- Sell assets operating convenants Value
• Seek government assistance - Settle respective
- Lower or raise tariffs • Owners infuse new capital • Solicit government support debt
- Reduce regulatory to break alliances
constraints • Restructure debt service by • Take equity ownership
lengthening debt service (last resort)

OH 4-8
 Common Examples of When to Use Exit
Strategy in Central and East European
Markets

• Many relationships show severely

weakened security realization with little
chance for improvement.

• Financial condition is severely weakened.

• Management integrity is often considered

poor.

OH 4-9
 Maximizing Recovery
X
100% 100%
Recovered

80% A

Net Liquidation
Value (NLV)
as % of 50% B
Exposure

0% 50% 90 % 100%

Probability of Success

(NLV - Costs) X Probability of success)

Exit Option: 80% X 50% = 40%
Restructure Option: 50% X 90% = 45% Appropriate Strategy - Restructure

OH 4-10
 Major Collection Costs

• Management time

• Administrative costs

• Legal costs

• Monitoring costs

• Adverse publicity

OH 4-11
 SECURITY REALIZATION SUMMARY - EXAMPLE
NET LIQUIDATION VALUE

2. Net Liquidation Value Level of Risk ER (Cedi 000)

Total

a. Assessed liquidation value 3,000 800 - 3,800

b. Liquidation value discount 50% 60% - N.A.

c. Time of sale 2 3 - N.A.

(Number of years)

d. Discount rate (%) 20% 20% - 20%

e. Net liquidation value 960 240 - 1,200

(a x b x (c+d))

f. Exposure (principle+interest) - - - 2,500

g. % NPV/Exposure -- security - - - 48%

cover (f/g)

OH 4-12
 Exit Strategy
Cooperative or Forced Approach

• Exposures can be reduced in a cooperative

fashion.

• Forced exits can be chosen and often

involved legal action.

OH 4-13
 Exit Approaches
POSITION EXIT OBJECTIVES EXIT APPROACH

• Weak security position

• Low convertibility of
security
• Maintain customer creditworthiness • Cooperative
• Relationship viability is while exiting
required

• Collection success is not

time sensitive

• Strong security position

• Low management
integrity
• Exit as soon as possible, disregarding • Forced
• Fraud highly suspected or maintenance of creditworthiness
proven

• Security realization and

value deteriorating

OH 4-14
 Choose the Approach that Maximizes
Net Liquidation Value

• The cost of postponing liquidation is

factored in to reflect the time value of
money.

• Different strategies have different

probabilities of success.

OH 4-15
 Government Support

• Many problem loans are for state-owned

enterprises.

• Request for government assistance is

reserved for large, very problematic
situations.

OH 4-16
 Examples of Credit Problems Requiring Government Assistance

Credit Foundation Credit Problems

Industry Dynamics • Government regulations are
hindering collections

Management Quality • Commitment of fraud

• Strong alliances used to
avoid/postpone obligations

Security Realization • Problems with evicting current

owner
• Unnecessary delays in court
proceeding
• Manager fled country

OH 4-17
 Restructuring Approaches
STEPS TO DEVELOP ACTION PLAN KEY ISSUES

Select Restructuring Actions which address credit • Identifying appropriate actions for each risk area
problems • Determining if actions are practical and achievable

Develop cash flow projections to assess selected • Assessing financial impact of selected actions
actions and determine credit requirements • Determining credit requirements given restructuring actions

Perform sensitivity analysis and determine ability to • Assessing likelihood of worst case
repay • Determining when credit facilities can be repaid

Restructure credit facilities and refine restructuring • Determining key restructuring parameters
actions • Restructuring against parameters to minimize risks

Develop specific action plan to implement • Developing key actions steps

restructuring approach • Assigning responsibilities and determining as a time line

OH 4-18
 Industry Dynamics
RISK AREAS POSSIBLE RESTRUCTURING ACTIONS RATIONALE/COMMENTS

Industry Environment • Diversify into other industries • Reconciling industry weaknesses is difficult to
• Obtain government support achieve
- Lower barriers
- Erect barriers
• Exit unattractive industries
• Start new business

Company Position • Strengthen specific weakness • A realistic view of a company’s position and
• Find attractive niche ability to improve its position is required to
• Create alliances to improve overall clout make proper decisions
• Exit if prospects are poor

Regulatory Factors • Obtain government relief from onerous • Government support unlikely if counter to
regulations overall policy
• Lobby government to create new
regulations to better protect the company

OH 4-19
 Financial Condition
RISK AREAS POSSIBLE RESTRUCTURING ACTIONS RATIONALE/COMMENTS

Liquidity • Obtain additional credit support • Possibility to coordinate action with other
• Restructure debt service (interest and creditors
principal) • Government support in encouraging owners
• Liquidate assets to increase capital could be helpful
• Secure additional investment of equity

Leverage • Liquidate assets • All three actions should yield a reduction in

• Obtain additional capital debt
• Forgive debt

Profitability • Restructure operations • Often requires a long time

- Require expenditure cuts • Could use knowledge of other customers’
- Increase efficiencies business to act as match maker
- Sell or close unprofitable
businesses
- Improve pricing
• Help company secure new markets

OH 4-20
 Management Quality

RISK AREAS POSSIBLE RESTRUCTURING RATIONALE/COMMENTS

ACTIONS

Integrity • Replace management • Integrity faults can rarely be fixed,

replacement is the only viable option

Competence • Impose operating • Operating guidelines or specific restrictions

guidelines/restrictions can help discipline and focus management
• Impose outside consultants • Outside consultants can fill the void in
• Replace management competence

Market Confidence • Replace management • Reputation difficult to repair once ruined

OH 4-21
 Security Realization
RISK AREAS POSSIBLE RESTRUCTURING ACTIONS RATIONALE/COMMENTS

• Perfection • Perfect security • Without perfection, security holds little or no

value

• Executability • Obtain government support with expediting • Most executability and time problems are due to
• Time Required to Sell the legal process slow or “affected” legal system

• Liquidation Value • Obtain additional security • Provides additional support for first way out
• Improve value of security • Increases options
- Upgrade facilities
- Complete project

OH 4-22
Cash Flow Projections Consider the Impact of
Restructuring Actions on:

• Major cash inflows

• Major cash outflows

OH 4-23
 Sensitivity Analysis

• Develop worst/best case assumptions for

each of the restructuring actions and other key
risk elements.

• Adjust projections to reflect new

assumptions under each scenario.

• Extend projections until debt can be repaid.

• Determine probability worst case will occur.

• After cash flow sensitivity analysis, reassess

the recovery strategy and revise as needed.

OH 4-24
 Recommended Structural Parameters

Amount Credit requirements, cash flow analysis and projections

Repayment Schedule Repayment ability based on projections

Security Security realization analysis, strength of first way out

Pricing Expected customer profitability (analysis not yet introduced)

Monitoring Requirements/Covenants Assessment of each credit foundation, identification of key risks

Documentation Key risks, security realization, management quality analysis

OH 4-25
 Action Plans include:

• A negotiating approach

• Detailed action steps

• Specific milestones

OH 4-26
 Discussion Questions

• What are the major causes behind the exit

or restructure decision?

• What would you consider when examining

if creditworthiness can be restored?

• What are some of the “fixes” available for

restoring creditworthiness?

• When is it best to exit?

• What role does the sensitivity analysis

play?

• What should be included in the action

plan?

OH 4-27
 NOTES

Strategy Development PG 4-28

 NOTES

Strategy Development PG 4-29

 NOTES

Strategy Development PG 4-30

 NOTES

Strategy Development PG 4-31

 NOTES

Strategy Development PG 4-32

 Unit 5:
Strategy Approval

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Problem Loan Recovery Process

Perform Develop
Recovery Recovery
I Analysis Strategy
D
- Industry Exit Approve Execute
E dynamics
N - Financial or
Recovery and
T condition Strategy Monitor
- Management
I quality
F - Security Restructure
Y realization

Establish Loan Loss Provisions

OH 5-1
 Objective

At the end of this unit, participants will be able to:

1. Prepare a recovery approval package that facilitates

communication, approval, monitoring, and
controlling the recovery strategy.

OH 5-2
 Purpose of Unit

The objective of preparing a recovery credit approval

package (CAP) is to facilitate communicating,
approving, monitoring, and controlling the recovery
strategy. It:

• Provides guidelines to Recovery Inspectors for:

- What data to obtain

- What analysis to complete for developing

strategies

• Establishes standard format for documenting and

communicating recovery analysis and strategies

OH 5-3
 Credit Analysis Package (CAP)

• Facilitates approval process. It:

- Makes available

♦ data
♦ analysis
♦ recommendations

- Highlights key issues

- Summarizes and presents critical information

in a succinct and accessible format

• Addresses and highlights key risks to focus the

monitoring process

• Documents the credit process to facilitate credit

auditing

OH 5-4
 Key Components of
Credit Analysis Package (CAP)

Recovery CAP is:

• Composed of eleven key components

• Assembled and prepared by the Recovery Officer

with assistance from technical and administrative
support

OH 5-5
 Sample CAP Components
RECOVERY CAP COMPONENT DESCRIPTION
MAIN DOCUMENTS

1. Credit Approval Summary Sheet • Summarizes key approval information and

contains approval signature
• Comprised of four key sections:
- Overview/approval
- Facilities
- Security
- Procedural information
2. Recovery Proposal Memo • Provides explanation of approval request
• Summarizes analysis, risk assessment
• Recommends credit action
SUPPORTING DOCUMENTS
3. Basic Information Report(1) • Summarizes key borrower information
relevant to credit analysis - Ownership/
Shareholdings, Management/Directors,
History, Creditors, Operations, Affiliated
companies
4. Financial Spread Sheets(1) • Presents financial information in standard
format to facilitate analysis - Profit/Loss,
Balance Sheet, Ratios, Cash Flow
5. Projection Forms(1/2) • Presents financial projections to determine
and structure credit facilities

OH 5-6
 Sample CAP Components
RECOVERY CAP COMPONENT DESCRIPTION
SUPPORTING DOCUMENTS
6. Risk Assessment Form 1) • Provides a summary of analysis of each credit foundation,
A. Overall Evaluation measurement of risk and identification of credit
B. Industry Dynamics problems
C. Financial Condition
D. Management Quality
E. Security Realization
7. Recovery Strategy Development Form • Presents analysis and rationale for selected strategy
• Provides detailed action plan
8. Request For Government Assistance • Provides rationale for government assistance and proposes
3)
role
9. Site Visit Report • Summarizes objectives, results and follow-up
requirements for site visits
10. Investigation Summary Form 1) • Summarizes findings from key investigations conducted
to gather and verify data
- Banks
- Buyers
- Suppliers
11. Security Documentation Check Off List • Summarizes results to security documentation review

1. Not required if company is bankrupt and in liquidation

2. Not required if exit strategy is being pursued
3. Only required if government assistance is requested
Note: Recommended forms for each document are presented in Appendix

OH 5-7
 Sample Recommended Recovery Proposal Memo Contents
TOPIC DESCRIPTION

I. Purpose of the Credit Analysis Memo • Summary of the purpose:

- Re-approve strategy
- Recommend initial/new strategy
- Restructuring facilities
- Increase facilities
• Brief description of relationship and facilities

II. Overview of Credit Quality (one section on each • Summary of analysis in each foundation with specific
credit foundation) discussion of the level of risk and credit problems
• Taken from Risk Assessment Form (RAF)

III. Credit Requirements and Two Sources of • Description of credit requirements based on
Repayment projections
• Specific discussion of two payment sources --
company cash flow and security
• Not required when exit strategy pursued

IV. Key Risks • Overall evaluation of the bank’s position highlighting

specific risks and possible fixes

OH 5-8
 Sample Recommended Recovery Memo Contents, continued

TOPIC DESCRIPTION

V. Recommendations/Recovery Strategy • Recommended strategy including:

- Exit vs. restructure
- Approach
- Action plan

• For restructuring strategy, includes six structural

elements
- Amount
- Repayment schedule
- Collateral
- Pricing
- Monitoring/Requirements/Covenants
- Documentation

OH 5-9
 Credit Inspector Responsibilities

• Expeditiously prepare initial preparation of the

CAP to minimize potential losses.

• Review in detail the relationship, at least once per

year

- Review each credit foundation to assess

changes in risks and credit problems

- Reassess strategy to determine if desired

outcome is achieved and if it is still
appropriate

- Revise strategy to reflect analysis

• Conduct a partial CAP for bankrupt customers in

liquidation

OH 5-10
 Credit Inspector Responsibilities, Continued

• Establish the next CAP review date -- 12 months

from current review

• Require preparation of the CAP and obtain

approval by review date. Failure results in
suspension of credit facilities. Failure:

- Represents exposure to risks not properly

assessed

- Forces prompt responses to complete CAP

OH 5-11
 Discussion

1. Why is a recovery approval package developed?

2. What are the main documents of the approval

package?

3. List several key supporting documents.

4. How much time should be given to prepare a

recovery CAP from identification of the problem?

5. Is a customer is bankrupt and in liquidation is a

recovery CAP required?

OH 5-12
 NOTES

Strategy Approval PG 5-13

 NOTES

Strategy Approval PG 5-14

 NOTES

Strategy Approval PG 5-15

 NOTES

Strategy Approval PG 5-16

 NOTES

Strategy Approval PG 5-17

 Unit 6:
Strategy Monitoring

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Problem Loan Recovery Process

Perform Develop
Recovery Recovery
I Analysis Strategy
D
- Industry Exit Approve Execute
E dynamics
N - Financial
Recovery and
T condition or Strategy Monitor
- Management
I quality
F Restructure
- Security
Y realization

Establish Loan Loss Provisions

OH 6-1
 Objective

At the end of this unit participants will be able to:

1. Identify and address recovery problems before

or immediately upon occurrence.

OH 6-2
 Objective of Recovery Monitoring

Early identification and recognition of problems is

critical to preventing additional losses. It:

• Allows the bank to act before problems

become severe

• Allows bank to adjust strategies more quickly

• Enables development of counter-action to

reduce exposure

OH 6-3
 Recovery Monitoring

Occurs at high intensity level because risk is

higher than for normal customers. Why?

• Changes in creditworthiness can occur rapidly

• Quick response to changes is often required to

protect the bank

OH 6-4
 Major Components of Recovery Monitoring

• Creditworthiness monitoring

• Recovery strategy monitoring

OH 6-5
 Customer Creditworthiness Monitoring

Follows the four foundations of the customer’s

creditworthiness

• Industry dynamics monitoring tracks changes

in industry elements

• Financial condition monitoring tracks the first

way out

• Management quality monitoring tracks

performance in meeting commitments and
action plans

• Security realization monitoring tracks the

second way out

OH 6-6
 Recover Strategy Monitoring

Tracks the execution of strategies.

• Confirms action steps have been taken

• Focuses on overall strategy execution success

• Identifies the need for strategy revisions

OH 6-7
 Early Warning Signals for
Monitoring Creditworthiness

Creditworthiness monitoring entails reviewing the

four credit foundations for “early warnings”
signals of possible problems.

• Early warning signals provide a basis for

identifying potential problems before further
deterioration results

• Each foundation, whether weak or strong,

requires constant monitoring

• Often strong foundations weaken during

strategy execution.

- Management integrity deteriorates

- Financial condition may deteriorate as

creditor support is lost

OH 6-8
 Early Warning Signals for
Monitoring Creditworthiness, continued

• Foundations improve

- Security realization strengthened by

pledge of additional security

- Financial condition may improve by

restructuring the balance sheet

OH 6-9
 Examples of Early Warning Signals

Foundation Warning Signals

• Intensifying competition
• Loss of market to substitutes
• Supply of disruptions/price increases
Industry Dynamics • Non-competitive cost structure
• Loss of market share
• Unusual asset/liability
• Below average performance
• Decline in net income
• Decline in liquidity
Financial Condition • Increase in leverage
• Deviation in borrowing patterns
• Lateness in payment
• Rumors of liquidity problems
• Poor account fluctuation

OH 6-10
 Examples of Early Warning Signals, continued

Foundation Warning Signals

• Changes in key executives/owners
• Evidence of weak controls
Management Quality • High staff turnover
• Evasive answers/delayed data, etc.
• Loss of control over collateral
• Evidence of high stress
• Evidence of self-dealing
• Evidence of poor business decisions
• Reputation declining
• Expired documentation
• Changes in market values/marketability
Security Realization • Increases in liquidation costs
• Evidence of collateral liquidation
• Legal process lengthening

OH 6-11
 Recovery Strategy Monitoring

Recovery strategy monitoring:

• Entails evaluating progress against plan

- Monitors execution

- Monitors customer progress against plan

- Documents progress and variances from

plan

• Evaluates need for strategy revisions

- Assesses implementation success

- Evaluates opportunities for improving

strategy

- Identifies when action steps for entire

strategy may need to be changed

OH 6-12
 Inform Senior Management

It is critical senior management is informed:

• Provides a steady progress update to gauge

creditworthiness and strategy effectiveness

• Allows senior management to assess possible

modification in remedial action

• May trigger prompt government action

OH 6-13
 Alternative Strategy Selection

Primary strategy may be unsuccessful:

• Lowest risk strategy to the bank is often

proposed first

• Customer may resist first strategy proposed

Conditions change requiring new strategies:

• Changes can be positive or negative

• New strategies may be tailored more to the

new conditions

OH 6-14
 Example of Critical Changes in Strategy

• Reversing restructure/exit strategy

• Allowing loan to remain unpaid and not

accruing interest

• Change interest rate charged

• Extending maturities

• Charging off principal

• Increasing exposure

• Reporting suspected fraud

• Reducing, forgiving principal or interest

• Giving up whole or part collateral

OH 6-15
 Discussion

1. What is the key objective of recovery

monitoring?

2. If monitoring is conducted properly, how are

additional losses prevented?

3. What are the two key components of

recovery monitoring?

4. If a warning signal is identified, list possible

actions to be taken by the bank.

OH 6-16
 NOTES

Strategy Monitoring PG 6-17

 NOTES

Strategy Monitoring PG 6-18

 NOTES

Strategy Monitoring PG 6-19

 NOTES

Strategy Monitoring PG 6-20

 NOTES

Strategy Monitoring PG 6-21

 Unit 7:
Case Study Discussion

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 FINANCIAL SPREADSHEETS
Company Name: Machine Engineers.
Amounts in: 000's ECU
Date (Day, Month, Yr): 1996 1997 1998 1999
Balance Sheet
DESCRIPTION AMOUNT % AMOUNT % AMOUNT % AMOUNT %

ASSETS

Fixed Assets
Land and Construction 122,099 160,392
Equipment 34,331 50,174
Technical means and equipment for accounting
Vehicles
Intangible assets 113 81 72
Other long-term assets 192,914 28,523 27,679 229,366

Current Assets
Currency 2,095 4,601 1,777 75
Raw materials reserve 27,719 21,372 13,733 10,924
Unfinished production 10,256 15,992 23,371 32,146
Finished articles 95 95 95
Clients' debts 39,926 48,713 43,459 33,208
Other short-term assets 1,501 1,637 1,533 10

Other Assets 99,696 199 136

TOTAL ASSETS 374,315 277,643 322,421 305,729

LIABILITIES
Owned Capital
Capital 215,848 205,777 209,214 148,227
Reserves
Undistributed profit 111,602 6,623 -60,987 (84,515)

Borrowed Capital
Short-term debt
To suppliers 14,802 31,834 60,508 68,224
To the budget
To the employees
To social insurance companies 102,428
To the banks
Other 25,789 9,564 82,345 20,838

Long-term debt
To the banks 20,082 24,592 33,075
Other 300 1,283 6,560

Accruals and deferred income 6,274 3,651 5,466 10,892

TOTAL CAPITAL 374,315 277,831 322,421 305,729

OH7-1
 FINANCIAL SPREADSHEETS
Company Name: Machine Engineers. Currency: 000's ECU
Amounts in: 000's ECU
Date (Day, Month, Yr): 1998 1999 2000
Profit and Loss
DESCRIPTION AMOUNT % AMOUNT % AMOUNT % AMOUNT %

Income from the main activity 97,704 102,124

Total input of the main activity
Direct input, Total
Raw materials 47,949
Outside Services 12,786
Direct Salary (Social taxes included) 65,469
Direct Depreciation expenses 14,022
Other direct expenses 3,962
Total cost of goods sold 144,188 149,143

Gross profit (46,484) (47,019)

Overhead expenses, Total

Salary and social taxes
Energy system of the enterprise
Depreciation
Other activity expenses

Profit from the main activity

Other Activity
Revenue
Expenses 1,492 12,773
Profit

Financial and investment activities

Revenue
Expenses 13,299 20,470
Profit

Extraordinary gains and losses (3,705) (1,287)

Profit before taxes (64,980) (81,549)

Profits tax 3,993 (2,966)

Net profit (60,987) (84,515)

Dividends

Retained profit

OH7-2
 FINANCIAL SPREADSHEETS
Company Name: Meble Express Ltd. Currency: 000's ECU
Amounts in: 000's ECU, Date (Day, Month, Yr): 1998 1999
Cash Flow Statement - Direct Method
DESCRIPTION
Sales-Net 1 102,124
(Inc) Dec in Receivables 2 11,319
3
Cash from Sales (1+2) 4 113,443
5
Cost of Sales (IS) 6 (144,224)
(Inc) Dec in Inventories 7 (5,416)
Inc (Dec) in Payables 8 7,716
9
Cash Production Costs (sum 5..9) 10 141,924
Gross Cash Margin (4+10) 11 28,481
Other Liabilities 12 5,426
S,G&A Expense (IS) 13
(Inc) Dec in Prepaids 14
Inc (Dec) in Accruals 15 (1)
Inc (Dec) Other Assets 16 136
Cash Operating Expense (sum 12..16) 17 5,561
Cash from Operations (11+17) 18 (22,920)
19
Miscellaneous Cash Income (IS) 20 9,244
Income Taxes Paid (IS) 21 (2,966)
Total (sum 19..21) 22 6,278
23
Net Cash from Operations (18+22) 24 (16,642)
25
Interest Expense (IS) 26 (20,470)
Dividends Paid/Owner Withdrawals 27
Extraordinary Loss (IS) 28 (10,531)
Financing Costs (sum 25..28) 29 (31,001)
Net Cash Income (24+29) 30 (47,643)
31
Current Portion Long-Term Debt 32
33
Total (31+32) 34
Cash after Debt Amortization (30+34) 35 (47,643)
Capital Expenditures 36 (8,741)
37
Total (36+37) 38
Financial Surplus (Requirements) (35+38) 39 (56,384)
Special Fund 40
Inc (Dec) Short-Term Debt 41
Inc (Dec) Long-Term Debt 42 13,760
Inc (Dec) Equity 43
Other Liabilities 44 40,921
Total External Financing (sum 40..44) 45 54,681
46
Cash after Financing (45+39) 47 1,703
Actual Change in Cash 0

OH7-3
 NOTES

Case Study Discussion PG 7-4

 NOTES

Case Study Discussion PG 7-5

 NOTES

Case Study Discussion PG 7-6

 NOTES

Case Study Discussion PG 7-7

 NOTES

Case Study Discussion PG 7-8

 Unit 8:
Summary

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means–electronic, mechanical, photocopying, recording or otherwise–without prior
permission of the United States Agency for International Development.
 Purpose

1. Participants will discuss how to apply the key

elements of the Problem Loan Management
course to their jobs.

Objective

1. At the end of this unit, participants will be able

to summarize the general principles related to
problem loan management.

OH 8-1
 Key Elements of Problem Loan Management

• Identify early problem loans, ensure they are

managed by the most appropriate resources
and ensure additional exposure incurred is
controlled to the advantage of the bank.

• Identify and assess credit problems and

evaluate the bank’s position to facilitate
recovery strategy development.

• Maximize recoveries through development of

appropriate action plans.

• Gain approval of strategies and action plans.

• Monitor recovery strategies to identify and

address problems before they occur.

OH 8-2
 Exercise

Part 1

1. List 5 key principles you want to remember

from the course and apply on the job.

2. Divide into groups of 3 to 4.

3. Discuss key principles and select at least 3

items to apply on the job.

4. Present two of your items to the large group.

OH 8-3
 NOTES

Summary PG 8-4
 NOTES

Summary PG 8-5
 NOTES

Summary PG 8-6
 NOTES

Summary PG 8-7
 NOTES

Summary PG 8-8