Understanding Loan Delinquency

Rationale  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 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 Delinquency? even one day Any loan with a missed amortization of even one day is a delinquent account.

What is zero tolerance 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 delinquency distinct from 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 Delinquency  Arrears Rate/Past Due Ratio  Portfolio at Risk Ratio  Annual Loan Loss Rate

Measuring Delinquency 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

Measuring Delinquency 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

Measuring Delinquency  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)

Measuring Delinquency PAR AgingLevel of Risk Current Loans with no miss payments and therefore LOW RISK PAR 1 – 7 Days Loans that are MINOR RISK BUT NEED WATCHING PAR 8 – 30 DaysMODERATE RISK PAR 31 – 60 Days Increasingly SERIOUS RISK PAR DaysLOW CHANCE OF REPAYMENT, lots of collection effort PAR over 91 DaysLOSS

Measuring Delinquency DELINQUENCY INDICATORS OVERDUE 1 – 30 DAYS OVERDUE 31 – 90 DAYS OVERDUE 91+ DAYS TOTAL OVERDUE OVERDUE ON MATURED LOANS Value of Late Payments As % of Outstanding Portfolio (=161,119) 12, % 6, % 6, % 25, % 5, % Value of Unpaid Balance As % of Outstanding Portfolio (=161,119) 39, % 30, % 20, % 89, % ---- Number of late borrowers As % of total active borrowers (=40) 8 20% % % 20 50%

Measuring Delinquency 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 PAR No Write off Policy INFLATES ASSETS Quick write offs underestimate portfolio health

Measuring Delinquency 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 unrecoverable Average outstanding portfolio

Is collection rate a tool for 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, 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 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 Delinquency PROFITABILITY SUFFERS THROUGH:  Direct Costs  Indirect Costs

DIRECT COSTS Expenses Income COLLECTION Loan Officers/ Management spend more time on it PROVISIONING Higher Loan Loss Provisions LEGAL FEES for pursuing most serious cases DELAYED INTEREST Negative Impact on Cash Flow SLOWER PORTFOLIO ROTATION Less Interest and fewer fees SLOWED PORTFOLIO EXPANSION Less Interest and fewer fees

Cost of Delinquency

RB Loan Data: Loan Amount P 15,000 Interest 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, 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 Delinquency Initial Loan Amount15,000 Interest (9% flat) 1,35016,350 Loan Term Weeks12 Weekly PRINCIPAL Repayment 1,250 Weekly INTEREST Repayment TOTAL Weekly Repayment 1, Payments Received56, (Total Weekly Repayment x 5) Payments Missed7 Lost Interest Income (Weekly Interest Repayment x 7) Lost principal8, (Weekly Principal Repayment x 7) Total LOST Principal & Interest Income 9, (Total Weekly Repayment x 7)

Cost of Delinquency ExpectedActual Revenue earned (15, weeks)1, Cost per Loan of loan) 150 Net Revenue per Loan1, Number of Loans Required to Earn Lost Principal Lost Principal/net revenue per 15,000 loan 8,750/1,2007 loans of P15,000 Number of Loans Required to Earn Lost Interest & Principal Lost Interest & Principal/net revenue per 15,000 loan /1,2008 loans of P15,000

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

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

Conclusion 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.