Oh Lordy, Please Make all those Defaulted and Delinquent Loans Disappear

In Central America where Prisma operates, the recession and political unrest have been reeking havoc with our loan portfolio.  Delinquency is rising as people hoard money for possible food shortages and the sheer uncertainty of the political situation.  With prolonged delinquency comes eventual higher rates of defaulted loans.  Loan demand is also dropping.  I was complaining to a colleague of a major MFI in Nicaragua that Prisma's overall delinquency which is now at less than 5% could double in the next few months.  His reply was that they were already at 12-15% and some other organizations were predicting 20-25%.

In my 30+ years in the industry, I've been through 2 of these down cycles before.  You buckle down, lower overhead, and work 24 hours per day to survive.  Lower overhead means less personnel and control of payroll where the ratio between the lowest paid and highest paid employees doesn't exceed about 1:7 or 700%.  If your teller is making $300 per month, your highest paid executive would be around $2,100.  An extremely hard pill to swallow for any ego-driven general manager.

Now comes the kicker.  How are you going to convince investors to keep pumping loan debt capital into your organization with such miserable delinquency and default statistics?  One of the oldest but newly introduced schemes in Latin America is to have your holding company form a new collections company and transfer all your bad stuff to that new company - clean your books, make them look perfect.  It's a real eye-opener when things have gotten so bad that you can no longer manage the problem in-house.

The eventual recovery on your defaulted loans may be less that 10%.  Instead sell them off to the new company at 50% and take a much smaller loss.  Keep the total loss to around 2% of the total value of the total loan portfolio.  The examiners and auditors will be very happy.  

Move those delinquent loans off the books and sell them to the collection company.  Keep the books clean and show delinquency of less that 5% of total portfolio.  Again the examiners and auditors should be happy, until they realize what you're doing.  How long that will take, I have no idea?

The new collection company can be minimally capitalized by your organization's holding company.  Move all your current in-house collection personnel to the new company and get those costs off your books.  The new company can sell collection services to other MFIs and make some money to cover overhead and the cost of subsidizing the purchase of your defaulted loans.  If the new company doesn't have lots of cash sitting around, convert the transaction to an accounts payable to the MFI and the MFI in turn records the transaction as an accounts receivable - you might get away with it for a few years.  This is one way of dealing with our industry's own toxic assets.

I may be dreaming, but it's one of my predictions that this scheme will play itself out over the next 5 years.

.....and I also want to next talk about why delinquencies were already starting to climb before the recession hit. 

Comments

[James]

I've got a lot to learn that's for sure. Your posts are helping with that, thanks. I'm looking forward to your insight on what is going on with the climbing delinquencies.

At what point do you think the practice of selling off the bad debt to the collections company crosses the line ethically speaking? If there is high delinquency wouldn't that be something that investors would want to know?

[Kendall Mau]

James, it all depends on the level of sophistication of the examiners and auditors. If they are local, they may not be able to pick up the presence of the new collection company because it would be registered in another country or set up as a completely hands-off transaction. With more experience and seeing more of such schemes being used, they will catch up and flag those organizations - it'll just take a little time.

Potential investors may also need time to obtain the knowledge and experience to look out for these new tools being used. The MFI industry is still young and many of the executives and boards have not yet been exposed to these more sophisticated mechanisms.

It may not be illegal to do, but morally it crosses the line as soon as a non-profit or not-for-profit organization participates. As for a for-profit organization, it's really up to the investors whether they agree or not.

My purpose for blogging on this subject - let the investors and main participants be informed and then develop their own opinions.