“Unprecedented times”, “financial crisis”, “credit crisis” and many other terms continue to be buzzwords that we hear every day. We are almost becoming desensitized to the terms, yet we feel the impact on a daily basis. Everyone is waiting for some positive news in the financial services industry and more bad news keeps coming.
Each quarter we continue to read about financial institutions claiming that the worst is over. They have recognized the risk in their portfolios through risk assessment, set aside adequate reserves or loan loss allowances and are now ready to turn the corner. Yet we continue to read about these same institutions coming back with more bad news, more credit losses and a restatement of the assurance that the problems have been recognized. As a result, this financial risk management has brought to light all of the high-risk accounts and the trend will begin to change.
Why does this story keep repeating itself?
Reason one
Management assesses to what extent the market (both stock market and the client base) will tolerate the level or degree of bad news, recognize losses to that extent and will then work hard to try to correct any known issues before we actually have to report the next quarter. Unfortunately, this approach simply delays the inevitable and brings into question the risk management practices of the particular institution. Like the boy who cried wolf, the more times you make a statement and it proves to be false, the less likely you will be believed the next time.
Reason two
The financial institutions are actually surprised each quarter with a new batch of credit losses. The institution, its credit management team and workout areas are diligently trying to address the current problem. But, just when they start to see the light at the end of the tunnel, a new batch of credit problems arise. For the most part, the credit issues still persist in the high-volume, low-dollar credits such as residential mortgages, home equity loans, automobiles, credit cards and small business loans. Due to the sheer volume of clients/loans, it becomes more difficult to assess what issues may be brewing in the portfolio. For the large volume, small dollar portfolios, the notion of a pending credit issue comes when the delinquency starts to rise to a delinquency of 60 or 90 days. The real issue is identifying those accounts that are likely to go 60 or 90 days past due and then assess the likelihood that they will go into charge-off.
Regardless of the reason, we have a “credibility” problem in addition to a “credit” problem.