Management of Hardcore Delinquent Accounts

Day II - Session 1

Loan Write Offs

Lesson Objectives

Understand the importance and basics of loan write-offs

Their advantages and disadvantages

Regulatory law in relation to write-offs.

Management of Hardcore Delinquent Accounts

Remedial Management includes a series of options to collect hardcode delinquent accounts. These options include:

• Loan write-offs • Debt Recovery Program• Collection Agencies• Legal options

Managed and Performed By a Remedial ManagementUnit within the Bank. This is the “Life After the Write-Off”

Loan Write OffLoan Write Off

REMEDIAL MANAGEMENT

IDENTIFY/CLASSIFYACCOUNTS

UNCOLLECTIBLECOLLECTIBLE

Debt Recovery Program

Collection Agencies

LegalActions

Flow of Procedures to Identify and Manage Hardcore Delinquent Accounts

Loan Write-Offs

Loan Write-Offs

Definition Removing a loan account from the

bank’s active portfolio and classifying that loan as written off

It is an accounting function where a written off account is classified from active to bad debts written off;

Why Write-Off Loans?

1. Allows the bank to recover the costs allocated for bad debts.

2. Trims the excess “fat” from assets, and reflects the true value of loan portfolio.

3. A unit (or RMU) can focus on collection and recovery.

4. Allows staff (account officers) to focus on the generation and management of quality accounts.

5. Provides more flexibility and options in recovering bad accounts.

What happens when bad debts are not written off?

Loan portfolio becomes loaded with non-performing assets; size of loan portfolio and assets becomes ‘misleading’.

Amount of portfolio at risk will continue to be high Instead of generating new and good accounts,

AOs & supervisors spend more time for follow up and collection that produces minimal results.

Bank does not get the benefits from the expenses already incurred for loan/loss provisioning.

Loan Write Offs . . .Advantages to the Lender

Balance Sheet• Cleanses and improves the portfolio quality

Income Statement• Helps reduce the bank’s tax liability• Written off accounts when collected turn into income

Loan Recovery• Loan write offs can be delegated to a specialized unit to focus on

recovery.

Tax Benefits from write offs: Illustrative Example

Item No write off With write off

Gross Income P100,000,000 100,000,000

Less:

Operating expenses 50,000,000 50,000,000

Other expenses 20,000,000 20,000,000

Provision for loan losses 5,000,000

(5,000,000)

5,000,000

(5,000,000)

Expense for Bad debts written off

0 5,000,000

Net income before tax P 30,000,000 P25,000,000 ??

Income tax due (32%) 9,600,000 8,000,000

Tax savings P1,600,000

NOTE: BIR recognizes provisioning as an expense only with actual write offs.

Sample MF Performance Data as of December 2006

Loan Portfolio P 55,445,225 Active clients 4,353 Allowance for Probable loss P 12.2 million Regular Loans P 6.8 million Microfinance Loans P 5.4 million MF Delinquency: PAR and Loan Loss Provision Required

PAR Ageing # Accts. PAR Amt %*/ Estimated Loan/loss provisions

PAR over 7 days 878 6,984,766 12.59% 211,399

PAR over 30 days 365 1,432,378 2.58% 398,455

PAR over 90 days 1667 3,985,367 7.18% 3,985,367

*/% of total MF loan portfolio

Loan Loss Provisioning

The setting-up and maintenance of sufficient reserves to absorb losses inherent in the loan portfolio or other bank assets.Loan Loss Provisions is an EXPENSE: required to be set up under BSP regulations; is charged to the bank’s current operations. a permanent cost item which cannot be

reversed, but needs to be replenished when the situation warrants.

Loan loss provisions and loan write offs

In order to benefit from this expense item, the bank must use it for the purpose it was created, that is, write off bad loans against the existing amount of provisions.

A bank with an adequate amount set up for loan losses need not incur additional expense when writing off bad loans.

In fact, the bank benefits from the tax that does not need to be paid on the amount written off during the period.

Loan Write OffsIllustration:

Balance Sheet

Total Loan Portfolio P xxxxxx

Less:

Specific Loan-loss provision ( xxxxxx )

General loan-loss provision ( xxxxxx )

Loan Portfolio – Net P xxxxxx

Note: The loan-loss provision stated in the balance sheet is an allowance serving

as reserves or buffer for future credit loss. It is only during actual write offs, that these reserves are utilized

Loan Write OffsIllustration:Income Statement

Total Operating Income P xxxxxx

Less:

Operating Expenses– Interest expense xxx– Compensation/benefits xxx– Bad debts written off xxx– Provisions (loan-loss) xxx– Etc xxx

Net Operating Income P xxxxxx

Extraordinary Credits– Recovery from Charged Off

NET INCOME BEFORE TAX P xxxxxx

Loan Write Offs

Accounting Entries:

1. Booking of Loan-loss provision

Dr. Loan-loss provisions expense

Cr. Allowance for Probable Loss

2. Booking of Write Off

a) Dr. Allowance for Probable Loss

Cr. Loan-loss provisions

b) Dr. Bad Debts Expense

Cr. MF loans

Loan Write-Offs - - - Disadvantages . .

The bank experiences a temporary reduction in portfolio and outreach

However –

-- removing hardcore delinquent loans from the portfolios of account officers and transferring them to a specialized unit for recover enables account officers to focus on monitoring exiting accounts and generating new productive accounts.

Loan Write-OffsRegulatory Policies –

BSP Cir. No. 409 (2003). Provides basic guidelines in loan/loss provisioning for microfinance

BSP Cir. No. 463 (2004). Implementing guidelines on write-offs issued in 2004

BSP Cir. No. 501 (2005). Amends and supercedes guidelines of Cir. 463. Banks need only notify the BSP, within 30 days after a write off (together with the basic requirements)

Loan Write-Offs

Procedural steps prior to write off The account officer prepares a PAR Aging Report based on

his/her delinquency report to identify accounts falling under PAR over 91 days (see MABS PAR Form 1.1).

Prioritizing accounts for loan write-off: the following “type” of accounts should be reviewed and considered as “priority” for write-off: • Accounts over 90 days PAR• Accounts for which the client cannot be located, is deceased or has

no source of income

Loan Write-Offs

Procedural steps prior to write offThe bank exerted all remedies and collections

efforts to collect from the client, such as those contained in the bank’s ‘alarm signals’ (See MABS PAR Form 1.2) Sent reminders and demand letters Collect from co-makers or co-borrowers Applied savings balances that guarantee the loan Gone after the serialized assets Filed legal or collection case (Barangay/Court)

Loan Write-Offs

The Process The MF supervisor validates the accounts

submitted by the account officers for write off, based on the procedural steps undertaken. If he finds merit to the list, recommends the same to the BM for endorsement to the BOD for approval;

For multi-branches, the product manager prepares a consolidated list for write-off based on the validations and recommendations of the branch MF supervisors. He submits the list to the president or GM for notation;

Loan Write-Off

The Process. . . After the president’s action, the list is submitted to the

bank’s Board of Directors for approval; After the BOD’s approval, the bank or branch can book the

write-off of the accounts; Within 30 days after the write off, the bank must notify the

BSP of such a write off together with supporting documents and other requirements

Loan and credit folders of written off accounts should be transferred to the Remedial Management Unit, if there is any, or a unit to that effect;

Loan Write-Offs

Documentary requirementso Notice of write off to be signed by the GM or

President;o Duly accomplished list of accounts for write off

(RB-COB Form 23);o Sworn Statement signed by the president or officer

of equivalent rank, that the same write off do not include DOSRI accounts;

o Board Resolution approving the write off.

Loan Write-Offs In Sum

Loan write-offs prevent the build up of worthless accounts in the bank’s portfolio – writing off cleanses and improves the portfolio

Adequate loan provisioning must be provided for delinquent accounts

Collection efforts do not end after writing off the loan. There are diverse recovery strategies.