Workout strategies for community banks

RMA Journal, The, Oct, 2003 by Kathleen M. Beans, Carol McGinn

What are cost-effective strategies for collection or workout of problem credits? How can your bank maximize recoveries from charge-off's? What are the current trends in problem credits? These issues and several others were discussed during a recent RMA audioconference by a panel of community bank executives.

Addressing a series of questions on detecting and handling problem credits, the panel agreed that the best workout strategies involve a four-step process: 1) proper underwriting/documentation, 2) monitoring, 3) watch list, and 4) exit strategy or rehabilitation strategy.

What follows is an edited transcript of the audioconference.

What trends do you see developing in problem credits at your bank?

Mikkalya Murray: We're beginning to see more pressure in the credit cycle. Although we're not displeased with tire asset quality numbers, they are up considerably from the low pristine numbers of a few years ago.

There's an increasing level of default within both the commercial and retail portfolios, which is manageable. However, there's no doubt that 2003 is going to be a bit more troublesome than 2002 in terms of workout and collection.

On the retail side, the largest number of losses comes from two groups. One is unsecured credit, where individuals are filing for personal bankruptcy. In our marketplace, and I believe throughout most of the Northeast, there's a tremendous increase in the percentage of losses coming from personal bankruptcies, in some cases, 60-70%. Poor resale values on used autos are another factor that has driven down the opportunity for recovery. If you have a consumer auto loan that goes bad, it has created additional risk of loss in the retail portfolio.

On the commercial side, the problems are varied. Our marketplace is extremely diverse. We're very fortunate in that we don't have any heavy industry concentrations. Actual losses in the portfolio occur when valuations and appraisals do not hold up to the liquidation values in the market--for instance, in manufacturing and plant equipment.

The residential real estate market remains hot and commercial real estate values are holding their own. However, we are concerned about a real estate equity bubble in the marketplace. In the risk management area, we are continuing to back-test that portfolio with automated loan-to-value products to see if LTV is, in fact, creeping up.

Richard W. Kordash: In tire Northwest the trend over the past 24 months has been positive. Our problem credits have been on a steady decline, and we're seeing that across the board in most every industry segment. We are noticing very soft markets for machinery and equipment, especially in liquidation scenarios. Agriculture, of course, is a substantial part of our portfolio, and that market is soft here, particularly the market for apples. There's a little uptick, though, this year in the apple market. There is increasing competition from foreign markets, which is causing a reshuffling of the apple industry.

Real estate has held up well, but we've had problems with convenience stores. Although those problems are mostly behind us, we are now cautious about lending to those stores.

We're also monitoring carefully our new programs on home equity lines and our credit-scored small business products. As a relationship bank, we're concerned because those kinds of loans are made based less on relationship and more on credit scoring. It's a bit of a departure from our culture so we monitor trends in those portfolios and address them early.

Ronald Shettlesworth: We're seeing a declining trend in our delinquencies, owing perhaps to a combination of our economy and a tightening of our underwriting standards. We're at less than 40 basis points as of April 30 in terms of a 30-day-plus delinquency.

But we're also losing some deals. Fewer and fewer deals are measuring up to our standards. We've not acquiesced to some of the stretch deals our competitors are doing. But as a result, we're working harder to replace runoff and grow our portfolio.

On the consumer side, we're seeing a lot of mounting credit card debt. Much of that debt is cleared when a homeowner refinances his or her mortgage. Along with the consumer leveraging up, we're seeing more declines in the credit scores. We pay close attention to an individual's personal credit score. From time to time, we'll get a report from a credit reporting agency showing all of the credit reports that we ordered and they'll give us a range of scores, which are often below 650. We start running for cover when scores start dropping below 650. However, it seems as if half or more of the applications we get just don't measure up. Our market is probably indicative of other markets. Auto financing is just about dead and has been for the past year or so with zero-percent financing. We're unable to maintain our consumer loan volumes.

How do you approach loan workout strategies?

Shettlesworth: The best workout strategies start the day the loan relationship begins. We ask borrowers to supply financial and other information at the appropriate times and intervals. It's also important to perform solid underwriting and collect detailed information. For example, if you do many loans that are secured by accounts receivable, it's important to get the names, addresses, and phone numbers on each of those accounts from your borrowers.