Managing Troubled Assets

Portfolio Management Series Webinar

Developed and delivered by

Introductions

Ray Waters– President, Enterprise Detroit

You, the participants– Small and Large CDFIs– Credit Unions and Banks– Consultants

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Overarching Themes

Jump on problems early– Much easier to bring a loan that is 15 days past

due to current than to rescue a loan 120 days past due

Diagnose the situation – Why is the borrower not paying? – What is really going on?

Protect collateral, security interests– What is your recourse if the borrower and loan

fail?

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

The Risk Grading System

Enterprise Detroit uses a risk grading system that goes from 1 (best) to 8 (worst)

All loans are assigned a grade at closing– Starting grades are usually a “4” or a “5”

Risk grades are adjusted upwards or downwards as necessary

By “Troubled Assets” we primarily mean– Loans on the Watch List (risk grade “6” in this

presentation)– Loans on the Problem Asset List (risk grade “7” in

this presentation)

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Progression from Past Due to Charge-Off Past Due List, Delinquency

Watch List– Borrowers late on payment, haven’t submitted

financials or other required information– Risk rating downgrade from 5 to 6

Problem Asset List– Borrowers with significant deterioration in financial

condition– Risk rating downgrade from 6 to 7

Non-Accrual Status– Subset of the problem asset list– All payment goes to principal reduction– Last resort before write-off

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Watch List (“6”) Description

Risk Factor Status

Cash Flow Borrower makes payments but calculated cash flow might not cover principal. Improvement in cash flow is uncertain. Borrower struggles to keep taxes current.

Balance Sheet High debt/worth ratio (>5:1). Perhaps negative working capital. May be slow in paying accounts payable.

Management Capacity

Management is inadequate, lacks depth, serious organizational shortcomings. FICO >/= 640

Collateral CCR less than 0.75 LTV greater than 1.2

Industry/Market Business has tough competition, relies on commodity pricing, or been negatively impacted by economic trends. Tough to make a profit.

Ability to Produce Financials

Business produces reliable financial statements at least twice/year.

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Problem Loan (“7”) Description

Risk Factor Status

Cash Flow

Cash flow does not cover interest payments. Borrower struggles to keep loan current. Taxes are past due.

Balance Sheet Negative or no net worth. Negative working capital. Very slow in paying accounts payable.

ManagementCapacity

Management struggling to demonstrate s/he has a viable business model. FICO <640

Collateral Loan is for all practical purposes, unsecured.

Industry/Market Significant deterioration in market has manifested itself in severe weakness in the borrower.

Ability to Produce Financials

Business has not produced reliable financials at least twice per year.

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Watch List

Typically flagged by loan officer: late on payment, hasn’t submitted financials or other required information

Loan officer can recommend downgrade of loan from 5 to a 6

Watch list candidate can also be identified from Portfolio Quality Report

At weekly staff meeting, talk about every problem loan and what to do for each of them

First step is lender visit -- get assessment of situation

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Problem Loan List Significant deterioration in financial heath of borrower.

Run UCC checks, new credit check, check if any new liens have been filed.

Try to determine what is the real situation.

Often means re-structure; forbearance agreements.

With 7s and some 6s, it’s an exercise in bird-dogging. Force them to meet with us.

Goal is not to write a company off. Better to restructure to fit the situation than to write off and go after the collateral.

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Loan scrutiny should be dictated by the loan policy and driven by the risk grade.

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Loan SizeCredit Grade

4 5 6 7

< $50m

F/S RequirementsBorrower submits semi

annual or quarterly financials

Copy of Income Taxes, business and personal, within 180 days of FYE

Copy of Income Taxes, business and personal, within

180 days of FYE

Copy of Income Taxes, business and personal, within

180 days of FYE

Lender ReviewReview Annually- Notes on

F/SLender reviews tax returns,

Notes on returnsMonthly update in PQR and Special Assets Committee

Monthly update in PQR and Special Assets Committee

Risk Manager Review

Annual Risk Rating Review Rating based solely upon receipt of tax returns and

payment history

Monthly update in PQR and Special Assets Committee

Monthly update in PQR and Special Assets Committee

Additional Upgrade, Work Out or Payoff Plan

Work Out, Payoff or Liquidation plan

Site Visits none required none required As Directed by Special Assets Committee

As Directed by Special Assets Committee

Customer Contact

Annually Semi-annually Based upon Upgrade, Work Out or Payoff plan

Based upon Work Out, Payoff or Liquidation plan

Other

Upon downgrade pull new Credit Report, lien search,

double check closing documents

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Loan scrutiny should be dictated by the loan policy and driven by the risk grade.

An action plan should be devised for each past due,

watch list and problem loan.

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Credit Status & Action Items Report

Company Name, Credit Status and Action Items

Action Items Date Preparer

Borrower:Underlying Problem:

Strategy/ Action Items:

When will loan be moved out or upgraded?

Status Report:

Action Items:

Responsible Parties:

Due Date:

Past Due List

Loan #1

Loan #2

Watch List

Loan #3

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Working with Difficult Borrowers

Common reasons why borrowers don’t pay:– Cash flow problems– More pressure from other creditors– Thinking you are their “partner” – not being tough

enough

How to determine the truth:– Dig through their financials– Be hands-on– “We trusted you to give you a loan; you have to be

honest with us”– Check credit scores; tax returns; personal financial

statements

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Working with Difficult Borrowers (cont’d) Negotiation tactics

Default interest rate

Obtain more collateral

Forbearance agreement

Restructuring – If the borrower agrees to certain conditions

Monitoring, review and update protocols

Documentation– Items to include in the loan file

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Collateral

Write-ups must show the collateral you have

Calculate your risk exposure– For example, in declining housing market, re-assess

value of collateral– Risk & Compliance Manager role

Protect your collateral interests; maintain collateral files– Must have mortgages, liens, collateral in line– Tickler system to make sure everything is current

Appropriate Staffing– One person should be responsible for maintaining all

UCCs, liens, mortgages, discharging mortgages, etc.

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Work-Out Strategies

Restructuring loans– When to do restructure; when not to

restructure– Calculating ability to pay– Determining appropriate terms

Use of forbearance agreements

Essential to have accurate valuation of collateral

Check personal guarantors

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Worst-Case Scenarios

Foreclosure processes

Putting it out to collection

Collateral

Personal judgments

Legal issues

Public relations/bad press

What to do with REO

CDFI Fund Capacity Building Initiative Managing Troubled Assets

Wrap-Up

This presentation is part of a series of four webinars, including:

CDFI Loan Policies and ProceduresRaising Debt and Equity from External SourcesRisk-Assessing Your Own OrganizationManaging Troubled Assets

To participate in upcoming webinars, register at:http://www.carseyinstitute.unh.edu/CDFI-webinars.html

For more information about the CDFI Fund’s Capacity Building Initiative, please visit:http://www.cdfifund.gov

CDFI Fund Capacity Building Initiative

Managing Troubled Assets

Wrap-Up

Sample documents, etc. will be available as part of a Resource Bank on the CDFI Fund’s Capacity Building Initiative webpage later this summer. Please see http://www.cdfifund.gov/cbi to view the Resource Bank and other helpful information on the Capacity Building Initiative.

As part of the CDFI Fund’s Capacity Building Initiative, free Technical Assistance (TA) and Organizational Assessments are available to certified and emerging CDFIs. To sign up, e-mail:

Jack Northrup at jack@nemarketresearch.com or Eric Hangen at ehangen@i2community.org

If you have not taken the survey, please do so at the following link: http://www.unh.edu/survey-center/cdfi.htmlCDFI Fund Capacity Building Initiative

Managing Troubled Assets

Managing Troubled Assets

Thanks for being with us today!

CDFI Fund Capacity Building Initiative Managing Troubled Assets