2nd State Bank lends Morgan Hoffman $200,000 to finance the purchase of a residential property. The loan agreement requires the Morgan Hoffman to make principal and interest payments based on a 3% interest rate for the first three years. After the third year, the interest payments reset to the prevailing market interest rate plus an additional 3%. At origination, the Morgan Hoffman expected the interest payments to reset to 5%. At the end of the second year, the Morgan Hoffman asks 2nd State Bank to modify the loan. Morgan Hoffman is not in default, but current market conditions indicate that the interest rate after year 3 will reset to 12%, leading to a substantial increase in the Morgan Hoffman’s payment. Morgan Hoffman informs 2nd State Bank that he does not believe that he will be able to make the scheduled principal and interest payments subsequent to the increase in the contractual rate on the loan.

Required:
How should 2nd State bank determine if Morgan Hoffman experiencing financial difficulty?