Problem loan identification and management.

Lessons learned from past economic cycles remind us that most bad loans are made at the end of an economic expansionary period. Thus, the time is ripe for all creditors to focus on the fundamentals of safe and sound underwriting and solid administration. Whitney National Bank can boast of five consecutive years of net recoveries; the bank attributes its success to the points found in this article, which draws from and expands on the author's "Subtle Indicators of Not-So-Subtle Problems," published in the February 1997 issue of The Journal of Lending & Credit Risk Management.

Clouds on the horizon suggest that our eight-year glide through the economic jetstream is ending. One cloud is the recession in Japan and softening in other Asian markets. Another cloud is weak oil prices. Yet another is wide swings with a general downward bias in the stock market. Looming just ahead is general economic weakness around the globe. And the horizon is darkened by Year 2000 and the impact this will have on the marketplace.

Various surveys conducted during the past few years indicated relaxed underwriting standards in the extension of credit, resulting in higher loan to value, longer terms, lower debt service, fewer covenants, and so forth. More recently, however, the slippage has slowed almost to a standstill. It is now incumbent on banks to shore up their administrative prowess in the identification and resolution of potential problems.

Sound administration means keeping a constant vigil on the financial health and well-being of the bank's borrowers. This entails frequent customer contact and monthly, or at least quarterly, updates of financial information.

Solutions Cost Time and Money

Early identification and acknowledgment of a problem is essential to satisfactory resolution, because both time and money are required to turn the situation around. Banks that identify problems early can be part of the solution and thus provide the added value of helping in time of need. On the other hand, banks that rely on lagging indicators - past dues, overdrafts, and levies - as the primary source of problem loan identification are often perceived as fair-weather lenders. Late identification of problems usually leaves the lender with fewer options, and these often are designed more to protect the bank than to help the borrower.

In the best of circumstances, the borrower alerts the bank that the business is not performing according to plan. If the bank …