4. Structuring the Workout Unit
Effective management of NPL resolution requires that the bank establish a dedicated unit to handle workout cases. Such Workout Unit (WU) should be established as a permanent unit within the bank's organizational structure reporting directly to the Risk Management function rather than the Business / Loan Originating Units.
The rationale for creating an independent unit for dealing with NPLs includes the elimination of potential conflicts of interest between the originating officer and the troubled borrower. The segregation of duties includes not only relationship management (negotiation of the restructuring plan, legal enforcement, etc.) but also the decision-making process along with support services (loan administration, loan and collateral files, appraisers, etc.) and technical IT resources.
The appropriate organizational structure of the Workout Unit varies greatly depending upon the circumstances each individual bank faces. Larger banks dealing with a significant number of NPLs are likely to establish separate Working Units or create sub-divisions within a single WU to handle different asset classes such as Large Corporates, Medium Corporates, Small and Micro loans. Smaller banks may have to follow a simpler structure where a single work unit may handle a wide variety of borrowers.
4.1 Staffing the Workout Unit
Skills Required
Banks should ensure that the managers of the WU, their team leaders and workout officers are highly qualified professionals, who would be able to discharge their functions effectively and in connection therewith, training needs should be assessed and proper training plans are to be prepared accordingly. Within the individual NPL WUs, more specialization is often useful based on the different NPL workout approaches required per relevant borrower segment.
Such workout officers should have strong analytical and financial analysis skills, understand the depth of the restructuring process and have the ability to work well under pressure.
Remuneration
Compensation structures for workout staff need to be aligned with long term strategy of the bank. If compensation is based on cash recoveries, officers may choose to optimize their own short-term income at the expense of longer-term profit maximization for the bank. Conversely, basing compensation on a reduction in the volume of non- performing loans may lead to improper restructuring or the bankruptcy of otherwise viable companies as officers seek to reduce the numbers by the quickest means possible. The staff may also be reluctant to employ the full range of restructuring options (particularly with respect to loan forgiveness) without provisions to indemnify them for costs and provide legal counsel to defend them in case legal charges are brought against them.
Assigning workload
Banks should establish policies specifying timelines for assigning stressed accounts to Work Officers, once the account is marked to be stressed.
4.2 Incorporating Legal and Support Functions Into Workout Unit
Banks require legal advice on a variety of matters related to the origination, management, and restructuring of loans. This includes not only documenting loan and restructuring transactions but also overseeing the collection process for those defaulted loans. It is highly recommended that Banks should maintain a dedicated legal team (or legal experts) within the Workout Unit to:
i. Assist in the negotiation of the restructuring of those loans that need to be addressed; and
ii. To be responsible for those loans that require legal solutions to be collected (bankruptcy or foreclosure).
4.3 Performance Management
For Workout Unit (WU) staff involved in the management of Nonperforming Loans (NPLs), proper performance metrics should be established which should cater not only to the individual’s performance but also assess the performance of the team as a whole. Further, the performance of the Workout Unit should be monitored and measured on a regular basis. For this purpose, an appraisal system tailored to the requirements of the NPL Workout Unit should be implemented in alignment with the overall NPL strategy and operational plan.
Further to quantitative elements linked to the bank's NPL targets and milestones (probably with a strong focus on the effectiveness of workout activities), the appraisal system may include qualitative measurements such as level of negotiations competency, technical abilities relating to the analysis of the financial information and data received, structuring of proposals, quality of recommendations, or monitoring of restructured cases.
It should also ensure that the higher degree of commitment, usually required of NPL WU staff is inculcated in the agreed working conditions, remuneration policies, incentives, and performance management framework.
As part of the performance measurement framework, it is recommended that banks' management should include specific indicators linked to the targets defined in the NPL strategy and operational plan. The importance of the respective weight given to these indicators within the overall performance measurement frameworks should be proportionate to the severity of the NPL issues faced by the bank.
Finally, given that the important role of efficient addressing of pre-arrears is a key driver for the reduction of NPL inflows, a strong commitment of relevant staff regarding the addressing of early warnings should also be fostered through the remuneration policy and incentives framework.
Technical resources
One of the key success factors for the successful implementation of any NPL strategy option is an adequate technical infrastructure. In this context, it is important that all NPL-related data is centrally stored in robust and secured IT systems. Data should be complete and up-to-date throughout the NPL workout process.
An adequate technical infrastructure should enable NPL WUs to:
i. Easily access all relevant data and documentation including:
a) current NPL and early arrears borrower information including automated notifications in the case of updates;
b) loan and collateral/guarantee information linked to the borrower; or connected borrowers;
c) monitoring/documentation tools with the IT capabilities to track restructuring performance and effectiveness;
d) status of workout activities and borrower interaction, as well as details on restructuring measures, agreed, etc.;
e) foreclosed (foreclosure is the repayment of the outstanding loans to the extent possible through, legal enforcement by a bank) assets (where relevant); and
f) tracked cash flows of the loan and collateral.
ii. Efficiently process and monitor NPL workout activities including:
a) automated workflows throughout the entire NPL life cycle;
b) automated monitoring process ("tracking system”) for the loan status ensuring a correct flagging of non-performing and forborne loans;
c) industrialized borrower communication approaches, e.g. through call centers (including integrated card payment system software on all agent desktops) or internet (e.g. file sharing system);
d) incorporated early warning signals (see also EWS section);
e) automated reporting throughout the NPL workout lifecycle for NPL WU management, senior management, and other relevant managers as well as the regulator;
f) performance analysis of workout activities by NPL WU, sub-team and expert (e.g. cure/success rate, rollover information, effectiveness of restructuring options offered, cash collection rate, vintage analysis of cure rates, promises kept rate at call center, etc.); and
g) evolution monitoring of portfolio(s) / sub-portfolio(s) / cohorts / individual borrowers.
iii. Define, analyze and measure NPLs and related borrowers:
a) recognize NPLs and measure impairments;
b) perform suitable NPL segmentation analysis and store outcomes for each borrower;
c) support the assessment of the borrower's personal data, financial position and repayment ability (borrower affordability assessment), at least for non-complex borrowers; and
d) conduct calculations of (i) the net present value (NPV) and (ii) the impact on the capital position of the bank for each restructuring option and/or any likely restructuring plan under any relevant legislation (e.g. foreclosures law, insolvency laws) for each borrower.
The adequacy of technical infrastructure, including data quality, should be assessed by an independent function on a regular basis (for instance internal or external audit).
4.4 Developing a Written Policy Manual
All the banks should have a documented Policy Manual, which evidently mentioned a clear standard timeline for NPL management and resolution. The longer a borrower remains past due, the less likely that the borrower is to repay the loan. A successful resolution, therefore, requires that the bank recognizes the problem early on and adheres to a tight but realistic timetable to ensure that the loan is restructured, sold to a third party, or collected through legal proceedings - in the case of non-viable borrowers) in a timely manner.