Identifying Troubled Loans Early: Five Practical Reads for Banks

Consumers and businesses are showing new signs of caution. In delaying purchases, avoiding new debt, and conserving cash, they could be responding to rising financial stress that will find its way to credit portfolios. For banks, it’s a good reminder to refocus on early warning signs of credit distress and strengthen plans for when borrowers fall behind. 

Here are five RMA resources that can help credit and risk teams take practical, proactive steps before small problems turn into big ones. 

What To Watch For
Early Warning Signs: Harbingers of Loan Distress and Default 
As loans are souring, the first red flags often appear well before a missed payment. This article outlines early signs of borrower distress—from subtle behavioral changes to measurable financial indicators—and explores how timely detection can shape intervention strategies. 

• Smart move: Conduct property inspections to check on the condition of loan collateral in-person and request invoices from the borrower that prove that proper maintenance of collateral is occurring. 

• Key quote: “Most loan documents require the borrower to maintain the collateral in good condition and not allow its ‘waste.’ However, monitoring collateral preservation is not easy and requires an especially vigilant or inquisitive banker.” 

Quantifying the Risk
A Practical Approach to Measuring the Probability of Financial Distress 
Once signs of trouble emerge, how can banks assess severity? This piece walks readers through a structured, spreadsheet-based method for calculating the likelihood of borrower failure, helping banks triage credit issues and plan appropriately. 

• Smart move: When testing a borrower’s projections, compare common-size expenses to peer averages—optimistic forecasts often crumble under this kind of scrutiny. 

• Key quote: “Earnings performance should be evaluated over the course of a complete economic cycle. Also, be wary of ‘adjusted earnings or EBITDA’ presentations. Assumptions for nonrecurring items must be scrutinized closely.” 

Strengthening the Response
Building and Boosting Your Bank’s Workout Team and Capabilities 
Loan workouts require more than technical knowledge—they demand empathy, documentation discipline, and a clear understanding of borrower dynamics. This article provides actionable tips for building or reinforcing a high-performing special assets function. 

• Smart move: Pair less experienced workout officers with low-risk, collateral-backed credits like CRE to build skills efficiently without exposing the bank to undue risk. 

• Key quote: “Experiences with reimbursement rates, how insurance companies work, and laws regarding Medicare and Medicaid for assisted living would all be beneficial for workout.” 

Setting the Standard
RMA’s Problem Loan Policy Tool 
To ensure consistency in how the bank handles problem loans, this resource—part of RMA’s Community Bank Resource Center—introduces a sample policy covering roles, procedures, and governance considerations. It’s a useful template for banks refining their internal guidance. 

• Smart move: Putting a strong problem loan policy in place helps bankers outline when and how loans transfer to special assets, ensuring clear ownership, faster resolution, and consistent treatment across the bank. 

• Key quote: “While banks typically have their own problem loan policies, reading one from another institution—such as this example—can help to identify market norms and determine if there are gaps in how the bank is mitigating risk.” 

Offloading Distress
Thinking of Reducing Your Bank’s Exposure to CRE? Here’s a How-To on Portfolio Sales 
When selling distressed or non-core loans, preparation is key. This article covers how to make a portfolio more attractive to buyers, navigate the sale process, and understand common pricing dynamics. 

• Smart move: Before launching a portfolio sale, set a firm cutoff date for any loan modifications. If changes can’t be finalized by then, pull the loan—to avoid buyer disputes and legal exposure. 

• Key quote: “While the industry may have considered these loans illiquid and hard to sell in the past, new technology and the development of secondary markets make it possible to manage loan holdings without offering huge discounts.”