How banks can maximise their options on Non-Performing Loans

Improving outcomes for distressed portfolios In this article, we highlight some key steps and considerations that lenders can consider building into their distressed portfolio workout strategies with a view to improving outcomes:

1. Classification and prioritization (identify focus accounts),
2. Engaging borrowers to understand management strategy, views and obtain information to inform decision making,
3. Diagnostic review and options analysis on select accounts to identify root causes of issues and formulate intervention mechanisms/approaches,
4. Monitoring the outcome of the selected option in order to track progress and confirm suitability and
5. Other key considerations.

1. Classification and prioritisation (Identify focus accounts) Based on their overall strategic objectives and priorities, banks should decide which accounts to focus on and dedicate their limited resources to those accounts. For example, a lender might decide to prioritize action based on the degree of distress across respective borrowers:

• recovery from borrowers who have already gone insolvent with little prospect of turnaround;
• supporting borrowers who are almost going insolvent and helping them to stabilize; and/or
• identifying early warning signs that could make performing borrowers quickly slide into the non-performing category.

To filter through the portfolio of distressed accounts effectively, banks can consider the quantum of exposure, industry or sector outlook, and pre-COVID performance.

Banks should also continue to proactively monitor the early warning signs and risk drivers, updated to capture the impacts of COVID-19, so that they can identify and manage these indicators in good time.

2. Engaging borrowers to understand management strategy, views and to obtain information for decision making Based on the prioritization of the key focus accounts, the bank must obtain relevant information in order to carry out a diagnostic review and to understand the actual factors influencing the borrowers underperformance, as well as to evaluate the most suitable options with respect to the borrower.

It is important that the banks’ data and strategies are elevated to identify which businesses are struggling due to COVID-19 issues and non-COVID-19 issues. A number of businesses were already suffering from other company specific issues such as over-leverage, poor governance, inadequate management and financial controls well before the pandemic.

3. Diagnostic review and options analysis 3a) Diagnostic review From the information obtained, the bank should carry out or, depending on the scale and complexity, appoint an independent party to carry out an in-depth review of the selected accounts to identify the root causes of the borrowers’ decline in performance. The key challenges facing a borrower may fall into various categories including:

• Financial challenges attributed to declining profitability or continuous losses, a spike in the costs structure, excessive gearing and inappropriate capital structure, loss making subsidiaries/branches/segments/products, liquidity problems (such as struggling to pay creditors due to weakening cash position), difficulties in refinancing/renewing banking facilities, etc.
• Operational challenges such as loss of key customers/suppliers, rapid and excessive growth, loss of market share, product/service offering in decline, difficulty integrating an acquisition, key suppliers/customers in financial distress, dependence on key customers/suppliers and poor control environment etc.
• Management challenges such as increased tension with stakeholders (particularly investors and bankers), poor corporate governance, attrition of key personnel (including directors), weak management and poor decision making, inability to articulate strategy, ill-defined business plans, unrealistic budgets, and poor budgeting processes etc.

As there is no ‘one size fits all’ type of solution, a proper understanding of the specific issues the borrower is facing will help a lender to develop innovative tailor-made solutions, particularly, for borrowers with complex operations/facilities.

3b) Options analysis – Evaluation and selection of the most suitable option With a proper understanding of the challenges or combination of challenges affecting the borrower, the bank should carry out an analysis of the strategic options available and select the most feasible option to support the borrower and/or recover the amounts owed. The broad options or combination of options which the bank, in collaboration with their clients, may consider implementing include:

• Financial restructuring strategies through re-negotiation of debt terms, refinancing of debt through equity or other debt, sale of assets or businesses, etc.
• Operational restructuring strategies such as working capital management, enhancing cost advantage, interim management, corporate simplification, etc.
• Recovery through enforcement of security and/or a sale of the business and/or the business’ assets.

4. Monitoring the outcome of the selected option in order to track progress and confirm suitability Finally, once the most feasible restructuring or recovery option is selected, banks need to ensure that they monitor the borrowers and their operations more frequently and at a greater level of detail to understand any key areas that might require further intervention.

With accurate quantitative and qualitative financial, industry and publicly available data, banks will be able to make more informed decisions, take corrective action early, adopt a more proactive portfolio monitoring process and enhance the quality of their credit portfolio(s).

5. Other key considerations

Collaboration with other key stakeholders in the formulation, selection and implementation of solutions When evaluating borrowers, we have noted that many borrowers increasingly have more complex lending arrangements with multiple financial institutions, as well as obligations to other creditors. Due to competing interests, certain stakeholders might be tempted to take measures to protect their own position, without regard to potential impact on the other stakeholders. This approach often undermines the effectiveness of any recovery or turnaround measures adopted, since uncoordinated action by different stakeholders can result in loss of value and minimises the options available.

In some cases, borrowers have used that ‘information asymmetry’ to their advantage. Lenders should, therefore, reflect on the need for collaboration with other key stakeholders (including other lenders) in the formulation and implementation of solutions so that any such solutions have the maximum support possible and, consequently, the highest chances of success. An experienced independent financial advisor can assist with coordinating the process of engaging with the different stakeholders and facilitate the development and implementation of the commonly agreed solution.