Losses are an inevitable part of lending.

This makes banks different from the manufacturer and service companies, whose objective is maximize revenue through sales of products and services.

To meet profit-growth objectives, a banker must boost both loan outstanding and spreads. Yet that same banker must also work to reduce risk.

The focus on cutting expenses has resulted in smaller staffs at banks. That has led to a rise in the number of customer per commercial loan officer.

A Case of Neglect

The account manager must keep as many balls in the air as possible. When one falls to the ground - in the form of a bad loan - it usually becomes another area's responsibility.

This area is collections. One has to wonder why the function that can have the greatest impact on a bank's bottom line has been so neglected. Nothing generates a higher return on capital than the recovery of assets already written off.

The decline in operating margins further dramatizes the opportunity. Before beginning to recover in the second quarter of 1991, the industry's spread between lending yields and funding costs shrank for the 100 largest U.S. banks, from over 4.8% in 1985 to under 4% in 1990.

Recovery Rate on Bad Loans

The best reflection of a bank's record on collections is its workout efficiency. Note on the graph that the ratio of recoveries to chargeoffs has declined significantly. Recoveries may be expected to be lag behind, in that loans must be written off before they can be recovered.

However, chargeoffs have grown consistently over the past six years while recoveries have remained almost flat. In fact, net chargeoffs as a percentage of loans for the entire industry have increased markedly, to more than 1.5% in 1991 from under 0.9% in 1986, according to Federal Deposit Insurance Corp. data.

The industry manages to collect $1 of every $7 written off. But 8% of the banks have been able to recover more than 30% of their average writeoffs over the past six years. The industry should aim to match the performance of that top tier.

An Underserved Stigma

Banks underallocate funds to their workout groups because of the embarrassment attached to bad loans. Officers assigned to recoveries consider it a negative career move, and it frequently is, which is not in keeping with its potential as a revenue source.

Bankers have the most intimate knowledge of their customers. If a bank employs the right people in workouts, it's in a good position to maximize the returns from bad loans, instead of ceding the profits to "sharks" or "vultures" seeking to exploit the bank's weaknesses.

It takes a different mind-set to be aggressive collectors instead of relationship managers. In these difficult times, that is where bankers need to focus their energies.

Mr. Cooperberg is with Marabead & Co., a consulting firm in Upper Montclair, N.J.

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