The last recession we went through in our country, not counting COVID, was in 2007-08. That is 15 years ago. When you look at your financial institution, consider how many of your lenders have been in the industry less than 15 years. New lenders in the industry (and for that matter old lenders) have focused on generating large loan volume. Liquidity was everywhere. Rates were low. Competition was fierce for loans and concessions were being made in underwriting, lower rates, and looser structure. Loan officers are hired as how successful of a producer they are and not how well they manage a portfolio. This is how we have been conditioned as an industry.

Even though we are not technically into a recession, the signs abound for problems ahead. Some of these are the inverted yield curve, high inflation, increased regulatory burdens, raising vacancies, and lower debt service coverages. We are bound to begin seeing more loans in 2023 that are will be moved to a watch or problem status as companies will not be able to adequately service their debt obligations.

If we are going to see more problems in our loan portfolios, is your institution ready to manage this? Many on your team have no experience with managing loans in these conditions. What are some practical strategies can you use right now to navigate through these times?

Begin with using each problem loan as a learning experience. One bank I worked for required that you write a “spilled milk report”. We had to identify what happened and when. Was there a problem in underwriting? Did we cut any corners? Was there a problem after the loan was closed? Did the business have a huge downturn after closing? What caused the business to fall? Answers to these questions then were used to see if changes needed to be made to loan policies and procedures. There could also be lessons for how to monitor and service the loan.

Not only is each problem loan a learning experience looking back from the time of the credit became challenged, but it is something to continue to learn from in managing the problem to either improve the credit, remove the credit from the financial institution (FI), or foreclose on the collateral. Each new problem credit offers new lessons. Over time, these can be amalgamated to create some best practices that help in managing new problem credits when they arise.

Next, remember that each problem commercial credit has people that are involved in each business that is your problem borrower. The best outcome for a problem loan occurs when you have the borrowers and guarantors working with and open to communication with the lender. Borrowers will go through a wide range of emotions when their business is not doing well. Your goal is to help them get through the feelings to work for the best outcome that allows you to have the highest probability of recovery. I have taught about the grief cycle and how this applies to a business or farm that is failing. The borrower getting to the last stage of this process is the best hope you have to be made whole.

Then, consider the team you have around you in managing these credits. You may have an individual who is not cut out to work with problem borrowers. Having them involved may do more harm to the FI than utilizing someone else. It is why you have certain people involved in consumer collections and others do not touch this.

Theoretically, the field officer on the account should be the best at identifying problems and working the borrower through them. There are sometimes that the officer is too close to the borrower to be objective about the lending situation. What do you do when your borrower coaches your son’s baseball team, is a deacon in your church, and is a member of the same Rotary Club as you are? Perhaps, you may be too close to the borrower to make hard objective observations and actions to best manage the credit.

Sometimes we found it more effective to transfer the problem credit to a different loan officer who is not in the community or tied to the borrower. Sometimes in rural ag banks, they transfer officers to different locations who are not tied to the community to work with the problem borrowers. In larger institutions, the problem loan is transferred to a special asset group (SAG). This group is run by experienced people in managing problem credits. At times, others outside the FI are used such as attorneys, title insurers, appraisers, and auctioneers.

If your FI does not have experienced team members to manage problem credits, consider bringing in an outside expert. We have a team of retired banking regulators and senior credit professionals who can help you in identifying and managing through problem credits to minimize any potential losses in your portfolio. Based on the findings, we can help identify any areas of your policy and procedures that should be revised.