Financial Difficulty

Definition

Financial Difficulty is a term used in the context of Credit Risk Analysis and management to identify or denote counterparties to credit contracts that are experiencing a change of circumstances versus those prevailing when they became party to the contract..

The term is very general and is used for any type of entity, but in particular in the context of Personal Finance and Corporate Finance.

Indicators of financial difficulty

• A counterparty is currently Past Due on any of its material exposures
• A counterparty is not currently past due, but it is probable that the counterparty will be past due on any of its material exposures in the foreseeable future without a concession (Forbearance), for instance, when there has been a pattern of delinquency in payments on the counterparty's material exposures
• A counterparty’s outstanding securities have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange due to Non Compliance with the listing requirements or for financial reasons
• On the basis of actual performance, estimates and projections that encompass the counterparty’s current capabilities, the bank forecasts that all the counterparty’s committed/available cash flows will be insufficient to service all of its loans or debt securities (both interest and principal) in accordance with the contractual terms of the existing agreement for the foreseeable future
• A counterparty’s existing exposures are categorised as exposures that have already evidenced difficulty in the counterparty’s ability to repay in accordance with the supervisory categorisation scheme in force or the credit categorisation scheme within a bank’s internal credit rating system
• A counterparty is in non-performing status or would be categorised as non-performing without the concessions
• The counterparty cannot obtain funds from sources other than the existing banks at an effective interest rate equal to the current market interest rate for similar loans or debt securities for a non-troubled counterparty

Issues and Challenges

• The concept of financial difficulty as used in this context is relative to an initial state of the borrower that was not in financial difficulty. Depending on prevailing laws and practices around lending, it is possible that borrowers may be in financial difficulty already at the start of the lending / credit relationship