Managing Delinquency

Session 4

Management of Hardcore Delinquent Accounts

Loan Write Offs

Management of Hardcore Delinquent Accounts

Remedial Management includes a series of options to collect hardcode delinquent accounts. These options include:

• Loan write-offs • Debt Recovery Program• Collection Agencies• Legal process

Managed and Performed By a Remedial ManagementUnit within the Bank. This is the “Life After the Write-Off”

Loan Write OffLoan Write Off

REMEDIAL MANAGEMENT

IDENTIFY/CLASSIFYACCOUNTS

UNCOLLECTIBLECOLLECTIBLE

Debt Recovery Program

Collection Agencies

LegalActions

Process Identify and Manage Hardcore Delinquent Accounts

Classification of Hardcore Accounts and Recommended Actions to be taken

Portfolio-at-Risk Aging Report

Loan Write-Offs

Lesson Objectives

Understand the importance and basics of loan write-offs

Advantages and disadvantages of writing off

Regulations in relation to write-offs.

Loan Write-Offs

Definition Removing a loan account from the

bank’s active portfolio and classifying that loan as written off

It is an accounting function where a written off account is classified from active to bad debts written off;

Why Write-Off Loans?

1. Allows the bank to recover the costs allocated for bad debts.

2. Trims the excess “fat” from assets, and reflects the true value of loan portfolio.

3. A unit (or RMU) can focus on collection and recovery.

4. Allows staff (account officers) to focus on the generation and management of quality accounts.

5. Provides more flexibility and options in recovering bad accounts.

What happens when bad debts are not written off?

Loan portfolio becomes loaded with non-performing assets; size of loan portfolio and assets becomes ‘misleading’.

Amount of portfolio at risk will continue to be high Instead of generating new and good accounts,

AOs & supervisors spend more time for follow up and collection that produces minimal results.

Bank does not get the benefits from the expenses already incurred for loan/loss provisioning.

Loan Write Offs . . .Advantages to the Lender

Balance Sheet• Cleanses and improves the portfolio quality

Income Statement• Helps reduce the bank’s tax liability• Written off accounts when collected turn into income

Loan Recovery• Loan write offs can be delegated to a specialized unit to focus on

recovery.

Tax Benefits from write offs: Illustrative Example

Item No write off With write off

Gross Income P100,000,000 100,000,000

Less:

Operating expenses 50,000,000 50,000,000

Other expenses 20,000,000 20,000,000

Provision for loan losses 5,000,000

(5,000,000)

5,000,000

(5,000,000)

Expense for Bad debts written off

0 5,000,000

Net income before tax P 30,000,000 P25,000,000 ??

Income tax due (30%) 9,000,000 7,500,000

Tax savings P1,500,000

NOTE: BIR recognizes provisioning as an expense only with actual write offs.

Loan Loss Provisioning

The setting-up and maintenance of sufficient reserves to absorb losses inherent in the loan portfolio or other bank assets.Loan Loss Provisions is an EXPENSE: required to be set up under BSP regulations; is charged to the bank’s current operations. a permanent cost item which cannot be

reversed, but needs to be replenished when the situation warrants.

Loan Loss ProvisioningAccounts Loan Loss

Provision Rate

Current1%

1-30 day PAR2%

31-60 days PAR and accounts restructured once 20%

61-90 days PAR 50%

PAR over 90 days and accounts restructured twice

100%

Loan Loss Provisioning ( Sample)

Accounts Portfolio at Risk Loan Loss Rate Loan Loss Provision

Current 18,500,000 1% 185,000

1-30 days 30,000 2% 600

31-60 days 50,000 20% 10,000

61-90 days 150,000 50% 75,000

Over day days 1,250,000 100% 1,250,000

Total 19,980,000 1,520,600

Loan loss provisions and loan write offs

In order to benefit from this expense item, the bank must use it for the purpose it was created, that is, write off bad loans against the existing amount of provisions.

A bank with an adequate amount set up for loan losses need not incur additional expense when writing off bad loans.

In fact, the bank benefits from the tax that does not need to be paid on the amount written off during the period.

Loan Write OffsIllustration:

Balance Sheet

Total Loan Portfolio P xxxxxx

Less:

Specific Loan-loss provision ( xxxxxx )

General loan-loss provision ( xxxxxx )

Loan Portfolio – Net P xxxxxx

Note: The loan-loss provision stated in the balance sheet is an allowance serving

as reserves or buffer for future credit loss. It is only during actual write offs, that these reserves are utilized

Loan Write OffsIllustration:Income Statement

Total Operating Income P xxxxxx

Less:

Operating Expenses– Interest expense xxx– Compensation/benefits xxx– Bad debts written off xxx– Provisions (loan-loss) xxx– Etc xxx

Net Operating Income P xxxxxx

Extraordinary Credits– Recovery from Charged Off

NET INCOME BEFORE TAX P xxxxxx

Loan Write Offs

Accounting Entries:

1. Booking of Loan-loss provision

Dr. Loan-loss provisions expense

Cr. Allowance for Probable Loss

2. Booking of Write OffReversal of the original entry:

a) Dr. Allowance for Probable Loss

Cr. Loan-loss provisions expense

Then:

b) Dr. Bad Debts Expense

Cr. MF loans

Loan Write-Offs - - - Disadvantages . .

The bank experiences a temporary reduction in portfolio and outreach

However –

-- removing hardcore delinquent loans from the portfolios of account officers and transferring them to a specialized unit for recover enables account officers to focus on monitoring exiting accounts and generating new productive accounts.

Loan Write-OffsRegulatory Policies –

BSP Cir. No. 409 (2003). Provides basic guidelines in loan/loss provisioning for microfinance

BSP Cir. No. 463 (2004). Implementing guidelines on write-offs issued in 2004

BSP Cir. No. 501 (2005). Amends and supercedes guidelines of Cir. 463. Banks need only notify the BSP, within 30 days after a write off (together with the basic requirements)

Loan Write-OffsRegulatory Policies –

BSP Cir. No. 745 (2012). Reporting Requirement on Write-off of Loans, Other Credit Accommodations, Advances and Other Assets.

- Notice of write off to be submitted in prescribed form to SES concerned within thirty (30) days after every write off with 1) sworn statement signed by the President or officer of equivalent rank that the write off did not include transaction with DOSRI and 2) a copy of the Board Resolution approving the write off.

Loan Write-Offs

Loan Write-Offs

Sent reminders and demand letters Collect from co-makers or co-borrowers Applied savings balances that guarantee the loan Gone after the serialized assets Filed legal or collection case (Small Claim Court)

Loan Write-Offs

For Multi-branches

Loan Write-OffThe Process. . .

Loan Write-Offs

Documentary requirementso Notice of write off to be signed by the GM or

President;o Duly accomplished list of accounts for write off

(RB-COB Form 23);o Sworn Statement signed by the president or officer

of equivalent rank, that the same write off do not include DOSRI accounts;

o Board Resolution approving the write off.

Loan Write-Offs In Sum

Loan write-offs prevent the build up of worthless accounts in the bank’s portfolio – writing off cleanses and improves the portfolio

Adequate loan provisioning must be provided for delinquent accounts

Collection efforts do not end after writing off the loan. There are diverse recovery strategies.