What’s the Cost of a Problem Loan?

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What’s the Cost of a Problem Loan?

A business owner comes in to your financial institution seeking a $2 million loan. She meets with one of your lenders, the underwriting process is completed, and the loan is approved. But what steps are you taking to ensure that your staff is appropriately evaluating industry, management, and operational risks, and thoroughly assessing the business’s financial condition? And what might it cost your organization if you don’t take those steps?

When a loan becomes problematic, it can be easy to blame the borrower, but a lack of experienced, properly trained staff, able to identify—and successfully mitigate—risks before they are realized, can also be to blame. How much can a lack of experience and training affect your bottom line?

To put it in perspective, think about the amount of new business your organization will have to generate to recoup the loss of principal (not to mention, the loss of interest and loss of opportunity) from just one charged-off loan. That amount can be expressed in the following formula:

NEW LOAN = CHARGE-OFF AMOUNT / PRETAX PREPROVISION MARGIN

Let’s imagine that $1 million of our business owner’s $2 million loan ultimately had to be charged off (and let’s assume a typical pretax preprovision margin of 2.5%). The lender would need to book $40 million in new loans ($1,000,000 / 0.025) just to earn back the principal on that one charge-off.

Now think about your loan volume and pretax preprovision margin. How long will it take your organization to recoup that loan loss?

To help reduce the number of loans that become problematic and affect your bottom line, make sure that you set aside adequate funding for training and that you equip your lenders and underwriters with the credit skills they need to successfully evaluate loans and mitigate risks. Omega Performance offers both foundational and advanced credit skills training courses to help your organization succeed in a competitive marketplace. Contact us today to learn more!

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