washington bankers association executive … - credit... · classifying troubled commercial real...
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June 2015
WASHINGTON BANKERS ASSOCIATION – EXECUTIVE DEVELOPMENT PROGRAM
Credit Risk & Review Understanding Credit Administration
Jeffery W. Johnson BANKERS INSIGHT GROUP, LLC
Washington Bankers Association & Bankers Insight Group, LLC Page 1
2015 EXECUTIVE DEVELOPMENT SERIES
CREDIT AND RISK REVIEW - CASE STUDY
QUESTION 1
Please provide a detailed explanation of the following regulatory credit risk rating categories on
a separate sheet:
SPECIAL MENTION:
SUBSTANDARD:
DOUBTFUL:
LOSS:
QUESTION 2
Additional classification guidelines have been developed to aid bankers and examiners in
classifying troubled commercial real estate loans. These guidelines are intended to supplement
the uniform guidelines for criticized and classified assets. After performing an analysis of a
Commercial Real Estate project and its appraisal, the banker and examiner must determine the
classification of any exposure.
The following Classification Categories are to be applied in instances where the obligor is devoid
of other reliable means of repayment as support of the debt provided solely by the Commercial
Real Estate project. If other types of collateral or other sources of repayment exist, the project
should be evaluated in light of those mitigating factors.
Please provide a detailed explanation of the following terms for Troubled Commercial Real
Estate Loan Classification:
SUBSTANDARD:
DOUBTFUL
LOSS
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QUESTION 3
Please provide a detailed explanation of the following terms for Troubled Commercial Real
Estate Loan Classification Guidelines utilized in credit administration as it relates to problem
loan management on a separate sheet:
NON-ACCRUAL LOAN:
IMPAIRED LOAN:
RECORDED AMOUNT OF A LOAN:
EFFECTIVE INTEREST RATE:
TROUBLE DEBT RESTRUCTURE:
QUESTION 3A
The original principal balance of a loan currently appropriately accounted for on nonaccrual was
$100,000. The borrower has made no principal reductions, but a month ago there was a $20,000
charge-off on the loan. The accrued interest is $25,000. The loan was purchased by the bank at
$106,000 and the unamortized premium is $5,000. The “recorded amount of the loan” is:
a. $75,000 b. $81,000 c. $106,000 d. $130,000
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QUESTION 3B
Which of the following two scenarios is/are considered “troubled” debt restructure?
A. A borrower’s 12 percent note matures, and the borrower negotiates with the lender to
renew the loan at 11 percent. The prime rate at the time of the renewal was 9 percent, and
the borrower could get a 2 percent over price prime loan at other banks.
B. A borrower is unable to repay $50,000 loan at maturity and gives the lender $27,000 in
marketable securities and real estate with a fair market value of $23,000 as full satisfaction of the
debt.
1. A
2. B
3. None of the above
4. A and B
QUESTION 4
Read each mini case carefully and identify the loans that should be evaluated for impairment and
state the reason(s) why and the loans that are not considered impaired and state the reason(s)
why.
Loan #1: Consumer Loan Balance $25,000
The bank currently holds the title to her 2005 Chevy Tahoe. The borrower has a 499 Beacon
score. She made 14 payments that were 30 days past due, six that were 60 days past due and one
that was 90 days past due. The loan is nonaccrual and the Bank does not expect to collect all
principal and interest payments.
Should this Loan be considered Impaired? Why or Why Not?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
Loan # 2: Subdivision Construction Loan Balance $650,000
This loan is for the development of one of the premier subdivisions in Vera, Illinois. The
developers are a group of doctors with high net worth and substantial cash flow. The developers
have asked for the terms of the loan to be modified with a single payment of the interest due six
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months from December 15 2007, and a reduction in the interest rate to prime plus .5 from a fixed
8.50 percent. The Bank expects to collect all principal and interest payments.
Should this Loan be considered Impaired? Why or Why Not?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
Loan #3: Subdivision Construction Loan Balance $450,000
This loan is for the development of one of the premier subdivision in Atlanta, Illinois with 45
lots. The developer is a residential home builder who has averaged building 30 houses a year for
2004, 2005 and 2006. During 2007, he only constructed ten, and 15 remain in inventory. The
developer has asked for the terms of the loan to be modified with a single payment of the interest
due six months from December 15, 2007, and a reduction in the interest rate to prime plus .5
from a fixed 8.50 percent. The Bank does not expect to collect all principal and interest
payments.
Should this Loan be considered Impaired? Why or Why Not?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
Loan #4: Subdivision Construction Loan Balance $300,000
This loan is for the development of one of the premier subdivisions in Vidalia, Illinois with 25
lots. The developer is a residential home builder who has averaged building ten houses a year
for 2004, 2005 and 2006. During 2007, he only constructed two and five remain in inventory.
The loan is on nonaccrual status. The Bank has advertised the property for foreclosure and does
not expect to collect all principal and interest payments.
Should this Loan be considered Impaired? Why or Why Not?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
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Loan#5: ABC Company Loan Balance $260,000
ABC Company is a manufacturing company which operates in Bloomington, Illinois. The
Bank’s collateral consists primarily of inventory, accounts receivable and the plant, which
represents only a small percentage of the loan balance. The loan payment history has been
extremely poor. The loan is on nonaccrual status and numerous meetings with management
indicate that the next 24 months will be critical to the company’s survival. The company has
brought in a turn-around specialist. Collection of all the Bank’s principal and interest is highly
unlikely.
Should this Loan be considered Impaired? Why or Why Not?
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
______________________________________________________________________________
QUESTION 5: Read the following case and answer the questions that follow.
Residential Loan with an Original Loan Balance of $260,000
The bank currently holds a first lien on the borrower’s home. The borrower’s business has suffered
greatly, and he is no longer able to make payments. The borrower is aware that if payment is not brought
current by January 15, the bank will be forced to begin foreclosure proceedings.
During August, the bank obtained an appraisal on the property for $315,000. A loan officer drove by the
property last week and noted that it appears the borrower no longer lives there. The property appears to
be in need of significant maintenance. The drive-by noted vandals have broken the large window on the
front of the house; therefore, the interior may also need repairs.
The loan officer conservatively estimated that it will take $15,000 to repair the property to get it into a
marketable condition. The Bank has noted a 15 percent reduction in the overall market values of real
estate over the last three months and expects selling costs to approximate 10 percent.
In view of the current situation, the bank charged off 10,000 in November 2010. The loan had $30,000 in
accrued interest remaining on the books as of December 31, 2010 and was placed on non-accrual at that
time. The Bank does not expect to collect all principal and interest.
1. Is the loan impaired (considering payment history, ability and intent of borrower to repay the
loan, and collateral value)?
YES state reason below
NO state reason below
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Reason for answer in one above:
2. Is foreclosure probable?
YES
NO
3. What is the Recorded Amount of the Loan?
A. $250,000
B. $290,000
C. $260,000
D. $300,000
4. If this loan is considered an Impaired Loan, which one of the following Impairment Analysis
Method should be used to determine the Impairment Amount?
A, Present Value of Future Cash Flow
B. Fair Value of Collateral Method
C. The Loan’s Observable Market Price
D. Historical Loss Rate on Similar Loans during the past two years
5. Calculate the amount of the Impairment considering the Appraised Value of the property; the
drop in Market Value; the amount required to sell and repair the property. Show your
calculations below.
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Recorded Amount of Loan
Principal Loan Balance
Accrued Interest
Principal Loan Payments
Amount Charged-Off
Recorded Amount of the Loan _______________
Fair Value of Collateral
Appraised Value ______________ Other Adjustments ______________ Other Adjustments ______________ Other Adjustments ______________ Adjusted Fair Value of Collateral ________________ Total Impairment Amount ________________
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QUESTION 6
Read each of the following cases regarding varying types of secured problem loans and answer
the questions that follow. All answers should be on a separate sheet to allow for the
development of your thoughts.
A. Income Producing Property – Office Building
A lender originated a $15 million loan for the purchase of an office building with monthly
payments based on an amortization of 20 years and a balloon payment of $13.6 million at the end
of year three. At origination, the loan had a 75 percent loan-to-value (LTV) based on an appraisal
reflecting a $20 million market value on an “as stabilized” basis, a debt service coverage ratio of
1.35x, and a market interest rate. The lender expected to renew the loan when the balloon
payment became due at the end of year three. The project’s cash flow has declined, as the
borrower granted rental concessions to existing tenants in order to retain the tenants and compete
with other landlords in a weak economy.
At maturity, the lender restructured the $13.6 million loan on a 12-month interest-only basis at a
below market rate of interest. The borrower has been sporadically delinquent on prior payments
and projects a debt service coverage ratio of 1.12x based on the preferential terms. A review of
the leases, which were available to the lender at the time of the restructuring, reflects the
majority of tenants have short-term leases and that some were behind on their rental payments to
the borrower. According to the lender, this situation has not improved since the restructuring. A
recent appraisal reported a $14.5 million “as stabilized “market value for the property, which
results in a 94 percent LTV.
What Loan Grade would you assign to this situation and explain your reasoning?
Should this loan be placed on Non-Accrual Status? Why or Why Not?
Should this loan be considered a Troubled Debt Restructure? Why or Why Not?
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B. Income Producing Property – Shopping Mall
A lender originated a 36-month $10 million loan for the construction of a shopping mall to
occur over 24 months with a 12-month lease-up period to allow the borrower time to achieve
stabilized occupancy before obtaining permanent financing. The loan had an interest reserve to
cover interest payments over the three-year term of the credit. At the end of the third year, there
is $10 million outstanding on the loan, as the shopping mall has been built and the interest
reserve, which has been covering interest payments, has been fully drawn.
At the time of origination, the appraisal reported an “as stabilized” market value of $13.5 million
for the property. In addition, the borrower had a take-out commitment that would provide
permanent financing at maturity. A condition of the take-out lender was that the shopping mall
had to achieve a 75 percent occupancy level.
Due to weak economic conditions, the property only reached a 55 percent occupancy level at the
end of the12-month lease up period and the original takeout commitment became void. Mainly
due to a tightening of credit for these types of loans, the borrower is unable to obtain permanent
financing elsewhere when the loan matured in February (i.e., due to market factors and not due
to the borrower’s financial condition).
The lender restructured the loan on an interest-only basis at a below market rate for one year to
provide additional time to increase the occupancy level and thereby enable the borrower to
arrange permanent financing. The level of lease-up remains relatively unchanged at 55 percent
and the shopping mall projects a debt service coverage ratio of 1.02x based on the preferential
loan terms. At the time of the restructuring, the lender inappropriately based the selection of the
below market interest rate on outdated financial information, which resulted in a positive cash
flow projection even though file documentation available at the time of the restructuring
reflected that the borrower anticipates the shopping mall’s income stream will decline due to rent
concessions, the loss of a tenant, and limited prospects for finding new tenants.
Current financial statements indicate the builder, who personally guarantees the debt, is highly
leveraged, has limited cash or liquid assets, and has other projects with delinquent payments. A
recent appraisal on the shopping mall reports an “as is” market value of $9 million, which results
in a LTV ratio of 111 percent.
What Loan Grade would you assign to this situation and explain your reasoning?
Should this loan be placed on Non-Accrual Status? Why or Why Not?
Should this loan be considered a Troubled Debt Restructure? Why or Why Not?
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C. Construction Loan – Single Family Residence
The lender originated a $400,000 construction loan on a single family “spec”
residence with a 15-month maturity to allow for completion and sale of the property. The loan
required monthly interest-only payments at a market rate and was based on a LTV of 70 percent
at origination. During the original loan construction phase, the borrower made all interest
payments from personal funds. At maturity, the home had not sold and the borrower was unable
to find another lender willing to finance this property under similar terms.
The lender restructured the loan for one year on an interest-only basis at a below market rate to
give the borrower more time to sell the “spec” home. The restructured loan has become 90+ days
past due and the borrower has not been able to rent the property. Based on current financial
information, the borrower does not have the capacity to service the debt. The lender considers
repayment to be contingent upon the sale of the property. Current market data reflects few sales
and similar new homes in this property’s neighborhood are selling within a range of $250,000 to
$300,000 with selling costs equaling 10 percent, resulting in anticipated net sales proceeds
between $225,000 and $270,000.
What Loan Grade would you assign to this situation and explain your reasoning?
Should this loan be placed on Non-Accrual Status? Why or Why Not?
Should this loan be considered a Troubled Debt Restructure? Why or Why Not?
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D. Commercial Operating Line of Credit in Connection with Owner Occupied
Real Estate
Two years ago, the lender originated a CRE loan at a market rate to a borrower whose business
occupies the property. The loan was based on a 20-year amortization period with a balloon
payment due in three years. The LTV equaled 70 percent at origination. A year ago, the lender
financed a $5 million interest-only operating line of credit for seasonal business operations at a
market rate. The operating line of credit had a one-year maturity and was secured with a blanket
lien on all the business assets. To better monitor the ongoing overall collateral position, the
lender established a borrowing base reporting system, which included monthly accounts
receivable aging reports. At maturity of the operating line of credit, the borrower’s accounts
receivable aging report reflects a growing trend of delinquency, which is causing the borrower
some temporary cash flow difficulties. The borrower has recently initiated more aggressive
collection efforts.
The lender reduced the operating line of credit to $4 million and restructured the terms onto
monthly interest-only payments at a below market rate. This action is expected to alleviate the
business’ cash flow problem. The borrower’s company is still considered to be a going concern
even though the borrower’s financial performance has continued to deteriorate and sales and
profitability are declining. The trend in delinquencies in accounts receivable is worsening and
has resulted in reduced liquidity for the borrower.
Cash flow problems have resulted in sporadic delinquencies on the operating line of credit. The
borrower’s net operating income has declined, but reflects the capacity to generate a 1.08x debt
service coverage ratio for both loans, based on the reduced rate of interest for the operating line
of credit. The terms on the real estate loan remained unchanged. The lender internally updated
the assumptions in the original appraisal and estimated the LTV on the real estate loan was
90 percent. The operating line of credit has an LTV of 80 percent with an overall LTV for the
relationship of 85 percent for the relationship.
What Loan Grade would you assign to this situation and explain your reasoning?
Should this loan be placed on Non-Accrual Status? Why or Why Not?
Should this loan be considered a Troubled Debt Restructure? Why or Why Not?
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E. Land Loan
Three years ago, the lender originated a $3.25 million loan to a borrower for the
purchase of raw land that the borrower was seeking to have zoned for residential use. The loan
had a three-year term and required monthly interest-only payments at a market rate that the
borrower has paid from existing financial resources. An appraisal obtained at origination
reflected an “as is” market value of $5 million, which resulted in a 65 percent LTV. The
borrower was successful in obtaining the zoning change and has been seeking construction
financing for a townhouse development and to repay the land loan. At maturity, the borrower
requested an extension to provide additional time to secure construction financing that would
include repayment of the land loan.
The borrower provided the lender with current financial information that indicated the borrower
is unable to continue to make interest-only payments. The borrower has been sporadically
delinquent up to 60 days on payments. The borrower is still seeking a loan to finance
construction of the townhouse development, but has not been able to obtain a takeout
commitment. A recent appraisal of the property reflects an “as is” market value of $3 million,
which results in a 108 percent LTV. The lender extended a $3.25 million loan at a market rate of
interest for one year with principal and interest due at maturity.
What Loan Grade would you assign to this situation and explain your reasoning?
Should this loan be placed on Non-Accrual Status? Why or Why Not?
Should this loan be considered a Troubled Debt Restructure? Why or Why Not?
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QUESTION 7
1. Which of the following is not one of the basic steps in the loan documentation process
of any secured transaction?
A. Identify the borrower and collateral
B. Report the documentation to the appropriate supervisory authority
C. Evidencing the debt
D. Attaching the collateral and perfecting the security interest
2. The primary document(s) used to identify the borrower and verify the name of a
corporation is:
A. Certificate of Good Standing
B. Articles of Incorporation and By-Laws
C. Corporate Resolution
D. Both A and B
3. According to Revised Article 9 of the Uniform Commercial Code, a registered
organization includes all of the following except:
A. Sole Proprietorship
B. Limited Partnership
C. Corporation
D. Limited Liability Corporation
4. Which of the following documents grants the authority to an individual to consummate
transactions such as signing checks and executing loan agreements on behalf of an
entity?
A. Promissory Note
B. Resolution
C. Power of Attorney
D. Incumbency Certificate
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5. Which of the following documents evidences debt and provides a mutual understanding
of the loan arrangement?
A. Security Agreement
B. Financing Statement
C. Promissory Note
D. Loan Agreement
6. The primary purpose of a Security Agreement is:
A. Subordinate debts owed to other creditors to the bank’s debt
B. Allow a third party to pledge their assets as collateral for a borrower’s debt
C. Impose financial covenants upon the borrowers as long as the loan is outstanding
D. Grant a security interest in assets pledged as collateral
7. Perfection of a security interest means:
A. Insuring the condition of assets taken as collateral is perfect
B. Attaching or obtaining a security interest in the collateral
C. Providing public notification of a security interest in the collateral and to establish
priority
D. Insuring all required documents are properly executed at the loan closing in the
collateral
8. If two creditors have placed a lien on the same collateral, but only one of the creditors has
perfected their lien, which event takes precedent in the order of priority in security
rights?
A. The order of filing
B. The order of attachment
C. The order of perfection
D. The order of evidencing the debt
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9. In order for a loan to be considered a Trouble Debt Restructure, which of the following
combined facts must be present?
A. The borrower is experiencing financial difficulty; the objective of the lender must
be to maximize recovery of its investment; there must be a formal written
agreement between the borrower and lender.
B. The borrower is experiencing financial difficulty; the objective of the lender must
be to maximize recovery of its investment; there must be a formal written
agreement between the borrower and lender; the bank makes a concession it
would not ordinarily make available.
C. The borrower is experiencing financial difficulty; the objective of the lender must
be to maximize recovery of its investment; there must be a formal written
agreement between the borrower and lender; the loan must be classified
Substandard
D. The borrower is experiencing financial difficulty; the objective of the lender must
be to maximize recovery of its investment; there must be a formal written
agreement between the borrower and lender; a charge-off of a portion of the loan
must have been experienced.
10. If a loan becomes Impaired, an Impairment Analysis must be performed. All of the
following are prescribed methods of determining the impaired amount except:
A. Observable Market Price
B. Fair Value of Collateral
C. Present Value of Future Cash Flow
D. Auction Value of Collateral