As defined in the “financial dictionary”, loan portfolios are loans that have been made or bought and are being held for repayment. Loan portfolios are the major asset of banks, thrifts, and other lending institutions. The value of a loan portfolio depends not only on the interest rates earned on the loans, but also on the quality or likelihood that interest and principal will be paid.
According to loan analytics (2004), loan portfolio planning deals with portfolio policies for instance cost allocation, risk identification, loan segmentation, , and profit maximization. Loan portfolio segmentation focuses on dividing the loan portfolio into homogeneous sub-portfolios, with each sub portfolio having customers and loans with similar risk characteristics.
Loan segmentation is done in order to create a risk efficient portfolio and to maximize the portfolio return at a given level of risk.
Decrease in portfolio risk through better risk identification and risk diversification increases portfolio profitability through the reduction of portfolio volatility and the increase in customer profitability. Antonio (2000)
Portfolio planning focuses on identification of sub-portfolio risk, effective loan portfolio performance embedded in the probability of default and loss as estimated in accordance with the type and capacity of the businesses of customers in a given sub portfolio. Many sub portfolio risk estimation methods exist such as migration and sub portfolio stress testing, but for MFIs, the method usually employed to identify sub-portfolio volatility considers group guarantees determined according to the level of trustworthiness and cooperation that the MFI has with the customers in a particular sub portfolio.
However, SACCOs in Uganda are vulnerable to risk of default, failing to recover loaned money from those they lend and to realize expected returns as pointed out by Bohnstedt (2000) casts doubts on how that their portfolio segmentation is conducted. Questions regarding how they come up with sub portfolios that do not support their stay in business remain unanswered; hence the need for this study to provide empirical answers.
Measuring loan portfolio quality is the key to loan portfolio management. With loan portfolio management as a process by which risks that are inherent in the credit process are managed and controlled. Assessing the current performance status of the most important assets of a financial institution in the loan portfolio is a basic requirement to actively manage the level of risk exposure and the profitability of an institution.
Portfolio quality indicators identify performing and non-performing parts of the loan portfolio and relate them to specific factors. These indicators provide a view of the status of the portfolio\'s performance by comparing them at different points in time. Trend analysis can be carried out in search for the specific reasons for positive or negative developments; portfolio information should be structured to enable managers to answer the following questions:
1. What percentage of the loan portfolio is non-performing?
2. What is the ratio of delinquent to active borrowers?
3. How many currently delinquent loans will turn out to be loan losses?
4. How strong is loan portfolio concentration in specific regions, sectors, products and loan term categories?
5. How does loan portfolio concentration relate to current and past portfolio performance?