Understanding Loan Delinquency. Rationale The loan portfolio is considered as the largest income- generating asset of a lending institution. Like

Understanding Loan Delinquency

RationaleRationale

The loan portfolio is considered as the largest income-generating asset of a lending institution.

Like any other asset, it has inherent RISKS! One of the biggest risks faced by the bank is non-

repayment by clients or delinquency. This risk in the bank portfolio changes as loans are disbursed.

Problems with loan delinquency affect not only loan clients but the whole institution and community as well.

However, the bank is ultimately responsible for delinquency.

Session ObjectivesSession Objectives

Understand the basic concepts of zero tolerance and delinquency

Learn how to measure delinquency Know the costs and causes

associated with delinquency

What is Loan What is Loan Delinquency?Delinquency?

Any loan with a missed amortization of even one even one

dayday is a delinquent account.

What is zero tolerance What is zero tolerance against deliquency ?against deliquency ?

Zero tolerance means NO LEVEL OF DELINQUENCY IS ACCEPTABLE!

It is the attitude of the bank management & staff towards loan delinquency – no level of late payment is acceptable. It is an institutional culture in which late payments are totally unacceptable

The bank will aggressively pursue past due clients, whatever the cost, to establish and maintain zero loan delinquency.

What makes loan What makes loan delinquency distinct from delinquency distinct from other problems?other problems?

The costs of delinquency are hidden. The true level of loan delinquency can be concealed, making it difficult to recognize the true extent of the problem.

Lenders tend to attribute delinquency excessively to external factors. Consequently, they do not confront and resolve the causative factors within their control.

Delinquency is contagious. It tends to spread and worsen, leading to high levels of default, unless it is aggressively controlled.

Measuring DelinquencyMeasuring Delinquency

Arrears Rate/Past Due Ratio Portfolio at Risk Ratio Annual Loan Loss Rate


Arrears/Past Due Rate Indicates how commonplace non payment is measures amount of loan principal that is due but

unpaid Less rigorous yardstick in measuring portfolio

quality Only shows amount of overdue payments Does not reflect portfolio risk Amount past due Total Loan Outstanding


Portfolio at Risk

Applicable measuring tool use to evaluate portfolio quality of microfinance loans;

it considers a loan account with a missed payment of even one (1) day as already a delinquent account

more pro-active approach in looking at delinquency problems

Unpaid Principal Balance of all loans with missed payments of 1 day or more

Outstanding portfolio


Indicates how much could a bank lose if all late borrowers default

Aging of portfolio at risk separates more risky loans from less risky (see next slide)


PAR Aging Level of RiskCurrent Loans with no miss payments

and therefore LOW RISK

PAR 1 – 7 Days Loans that are MINOR RISK BUT NEED WATCHING

PAR 8 – 30 Days MODERATE RISK

PAR 31 – 60 Days Increasingly SERIOUS RISK

PAR 61 90 Days LOW CHANCE OF REPAYMENT, lots of collection effort

PAR over 91 Days LOSS

Measuring DelinquencyMeasuring DelinquencyDELINQUENCY INDICATORS

OVERDUE1 – 30 DAYS

OVERDUE31 – 90 DAYS

OVERDUE91+ DAYS

TOTALOVERDUE

OVERDUE ON MATURED

LOANS

Value of Late Payments

As % of Outstanding Portfolio (=161,119)

12,904

8.0%

6,583

4.1%

6,094

3.8%

25,581

15.9%

5,462

3.4%

Value ofUnpaid Balance

As % of Outstanding Portfolio (=161,119)

39,119

24.3%

30,095

18.7%

20,314

12.6%

89,557

55.6%

-

-

Number of late borrowers

As % of total active borrowers (=40)

8

20%

7

17.5%

5

12.5%

20

50%


Loan Loss Rate Shows how much of the portfolio has been lost; annual cost

of default, which must be balanced by higher interest income

Measures the amount written off as a percentage of average outstanding portfolio

Provides a complement to PARNo Write off Policy

INFLATES ASSETS

Quick write offs underestimate portfolio health


Loan Loss Rate

Complements the portfolio at risk rate (PAR) Compare over time to see if write offs are increasing Loan loss rates over 4% are dangerous – best kept

under 3% MFI should continue efforts to recover loans that are

written off

Amount declared unrecoverableAverage outstanding portfolio

Is collection rate a tool for Is collection rate a tool for measuring delinquency?measuring delinquency?

Collection/ Repayment Rate Frequently misused to report portfolio quality Measures amount repaid as % of amount expected to be

repaid Does not reflect portfolio risk

Used to: Predict and plan cash flow Analyze repayment trends Examine collection performance

Amount received in a given period From cash flow

Amount due during the period From portfolio report

Is a 95% collection rate good?

95% collection rate (amounts received/amounts due)

Total amount disbursed = P500,000

500 loans: P 1,000 principal disbursed, repaid in 10 weekly installments of P100 each. Loans renewed every 3 months

P 500,000 Loan Disbursement (LD) - 475,000 Recovered amount ( LD x 95%) 25,000 lost PER LOAN CYCLE x 4 cycles per year 100,000 Total amount lost for 4 cycles/ 1 year 100, 000/ Total amount lost for 4 cycles/1 year 500,000 Original amount of Loanable Funds = 20% of portfolio lost in effect every year

Do not simply assume that a repayment rate 95% is good. Delinquency hurts because it eats away the amount of money you have to lend to other borrowers.

Implication of 95% CR

Why is delinquency not Why is delinquency not acceptable?acceptable?

Why is delinquency not Why is delinquency not acceptable?acceptable?

It reduces profitability; It reduces the bank’s competitiveness; It affects the bank’s image in the community negatively

BANK FAILURE!!!

can lead to:

Impact of DelinquencyImpact of Delinquency

PROFITABILITY SUFFERS THROUGH:

Direct Costs Indirect Costs

DIRECT COSTSDIRECT COSTS

Expenses

Income

COLLECTIONLoan Officers/Management spend moretime on it

PROVISIONINGHigher

Loan LossProvisions

LEGAL FEESfor pursuing most serious

cases

DELAYED INTEREST

Negative Impacton

Cash Flow

SLOWER PORTFOLIOROTATION

Less Interest andfewer fees

SLOWEDPORTFOLIOEXPANSIONLess Interest

and fewer fees

Cost of DelinquencyCost of Delinquency Data The RB with High The RB with Low

Delinquency DelinquencyLoan Portfolio Amount PAR% Amount PAR%

Current 8,000,000 80% 9,700,000 97%

PAR

1 - 30 days 100,000 1.0% 150,000 1.5%

31 - 60 days 400,000 4.0% 100,000 1.0%

61 - 90 days 500,000 5.0% 40,000 0.4%

Over 90 days 1,000,000 10.0% 10,000 0.1%

Total 10,000,000 10,000,000

Interest Income 45% 3,600,000 4,365,000

Cost of Funds 10% 1,000,000 1,000,000

Operating Costs 20% 2,000,000 2,000,000

Loan Loss Provision

Current 1% 80,000 97,000

PAR

1 - 30 days 2% 2,000 3,000

31 - 60 days 20% 80,000 20,000

61 - 90 days 50% 250,000 20,000

Over 90 days 100% 1,000,000 10,000

Total LLP 1,412,000 14.12% 150,000 1.50%

Profits (812,000) -8.12% 1,215,000 12.15%

Cost of DelinquencyCost of DelinquencyRB Loan Data:Loan Amount P 15,000Interest 3% per month Term 3 months(12 weeks)

Assumptions:The loan has become a problem account. After receiving only 5 full

payments of principal and interest, the borrower has fled the municipality. The total payment amount due per week on this loan is P1,362.50

Assume that cost per loan for the RB has been calculated at P150.

Requirement:Calculate for the following: a) lost interest income, b) lost principal,

c) net revenue per loan, d) number of loans required to earn the lost principal and interest.

Cost of DelinquencyCost of DelinquencyInitial Loan Amount 15,000

Interest (9% flat) 1,350 16,350

Loan Term Weeks 12

Weekly PRINCIPAL Repayment

1,250

Weekly INTEREST Repayment

112.50

TOTAL Weekly Repayment

1,362.50

Payments Received 5 6,812.50 (Total Weekly Repayment x 5)

Payments Missed 7

Lost Interest Income

787.50 (Weekly Interest Repayment x 7)

Lost principal 8,750.00 (Weekly Principal Repayment x 7)

Total LOST Principal & Interest Income

9,537.50 (Total Weekly Repayment x 7)

Cost of DelinquencyCost of DelinquencyExpected Actual

Revenue earned (15,000 loan@ 12 weeks)

1,350 562.50

Cost per Loan (assumed@10% of loan) 150 150

Net Revenue per Loan 1,200 412.50

Number of Loans Required to Earn Lost Principal

Lost Principal/net revenue per 15,000 loan

8,750/1,200 7 loans of P15,000

Number of Loans Required to Earn Lost Interest & Principal

Lost Interest & Principal/net revenue per 15,000 loan

9537.50/1,200 8 loans of P15,000

INDIRECT COSTSINDIRECT COSTS

Breakdown of credit discipline; Reduced staff morale; Reduced access to fund sources

ConclusionConclusion

Delinquency hurts!

It hurts the bank where it matters most –PROFITABILITY AND IMAGE IN THE COMMUNITY.

ConclusionConclusion

There is a direct link between an increase in delinquency and decrease in the bank’s profitability and sustainability.

There is also a direct reduction in staff productivity when delinquency increases.

The bank ultimately loses the opportunity to fulfill its business objectives – that of making a profit and providing credit access to the community – as it either runs out of money, or focuses too much time on chasing delinquent loans.

Documents

Understanding Loan Delinquency. Rationale The loan portfolio is considered as the largest income- generating asset of a lending institution. Like