WASHINGTON BANKERS ASSOCIATION EXECUTIVE … - Credit... · classifying troubled commercial real estate loans. These guidelines are intended to supplement the uniform guidelines for

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


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


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


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.


______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

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.


______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

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.


______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________


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.


______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

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


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.


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 ________________


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?


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.





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.





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.





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.





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


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


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


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


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


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

Documents

WASHINGTON BANKERS ASSOCIATION EXECUTIVE … - Credit... · classifying troubled commercial real estate loans. These guidelines are intended to supplement the uniform guidelines for