Costs of Delinquency MABS Regional Roundtable Meeting of Mindanao Participating Banks October 26, 2005 Grand Regal Hotel, Davao City
Why Prevent, Monitor and Control Delinquency? • The portfolio is the biggest income-generating asset • Delinquency affects good borrowers • The MFI is responsible for delinquency
Why Measure Delinquency? A portfolio has inherent RISK! RISK in the portfolio changes as loans are disbursed and payments made.
Measuring Delinquency • Arrears Rate/Past Due Rate • Repayment/Collection Rate • Annual Loan Loss Rate • Portfolio at Risk Ratio
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 notreflect portfolio risk Amount past due Total Loan Outstanding
Measuring Delinquency Repayment Rate • Frequently misused to report portfolio quality • Measures amount repaid as % of amount expectedto be repaid • Doesnotreflect 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
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 writtenoff Amount declared unrecoverable Average outstanding portfolio
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)
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.
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 PROVISIONING Higher Loan Loss Provisions LEGAL FEES for pursuing most serious cases COLLECTION Loan Officers/ Management spend more time on it 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 P1,362.50 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 Is a 95% collection rate good? 95% collection rate (amounts received/amounts due) Total amount disbursed = P500,000 500 loans: P 1,000 principal disbursed, repaid in 10 weekly installments of P100 each. Loans renewed every 3 months
Cost of Delinquency P 500,000 disbursed - 475,000 recovered (500,000 x 95% rec. rate) 25,000 lost PER LOAN CYCLE x 4 cycles per year 100,000/ 500,000 lost per year = 20% of portfolio lost 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.
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.