TE Study Guide - Loans (3.2)
Commercial Loan - What are the common terms for considering a business has adequate repayment capacity to de-leverage?
Ability to amortize debt or repay at least 50% of total debt within 5-7 years.
Commercial Loan - What is a Term Business Loan typically used for?
Acquiring capital assets like plant and equipment.
Oil and Gas Lending - What is the Advanced Rate for high-quality proved reserves? What is the rate for other reserves risk adjusted?
Advanced Rate is 65%. Other reserves should not exceed 25-35%.
Oil and Gas Lending - What is the primary underwriting tool in Reserve-Based Lending?
An Independent Engineering Report. Must be detailed and prepared by a competent engineering group that addresses pricing, discount factors, and timing.
How does the Loan section relate to Part 364?
Appendix A to Part 364 for Establishing Standards for Safety and Soundness has operational and managerial standards for AQ, internal controls, credit underwriting, and loan documentation.
How often should Loan Review Policies be reviewed and approved by the Board?
At least annually.
Commercial Loan - What is the Asset valuation based on?
Based on assets in terms of net going-concern or liquidation value
Commercial Loan - What is the Income valuation based on?
Based on ongoing cash flows or earnings and aplly capitalization or discounting techniques.
Independence of loan review personnel - To avoid conflicts of interest, what should management do, when feasible, on all significant loans?
Be reviewed by individuals that are not part of, or influenced by someone associated with the loan approval process.
Workpaper and Report Distribution - A report that summarizes the results of review are typically reported to who and how often?
Board at least quarterly.
Allowance for Loan and Lease Losses (ALLL) - When there is a Loss Contingency what should be done?
Charge to income (provision) if it's probable the loss will incur and the amount of the loss can be reasonable estimated.
Commercial Loan - What is Market valuation based on?
Comparable company data or sales transactions
Oil and Gas Lending - What is a Price Deck forecast?
Forecast used to derive CF and collateral assumptions
Commercial Loan - What is Oil and Gas Lending?
Highly complex and specialized type of lending
Oil and Gas Lending - When can lenders consider reserves being "proved reserves"?
If at least 90% probability that the quantities actually recovered will equal or exceed the estimate for determining collateral value.
Commercial Loan - What is Leveraged Lending?
Important type of financing for national and global economies, and US financial industry. Plays integral role in making credit available and syndicating that credit to investors.
Commercial Loan - Out of the three valuation methods, what is the most reliable?
Income
Current Expected Credit Losses (CECL) - If there are changes to ACL resulting from periodic evaluations, what should be done?
Increase or decrease to the related provisions for credit losses (PCL)
Current Expected Credit Losses (CECL) - What change is made to the inputs from the existing reserve methodology?
Inputs to a loss rate method would need to reflect expected losses over the contractual term, rather than the annual loss rate commonly used under the existing methodology.
What does it mean that the Lending Policy is not a static document?
It means that the Policy be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs.
Credit grading systems place primary reliance on who for identifying emerging credit problems?
Loan Officers
Oil and Gas Lending - What would be a weakness in Reserve-Based Lending?
Loan balance exceeds 65% of the present value of CFs. This shows it will not amortize by reserves half-life.
Oil and Gas Lending - What is Reserve-Based lending?
Loans for exploration and production (Upstream) that is typically secured by proved reserves and governed by a reserve-based borrowing base.
Portfolio Composition - What is a Commercial Loan?
Loans to business enterprises for commercial or industrial purposes. Can be secured or unsecured and have LT and ST maturities.
Workpaper and Report Distribution - What should examiners review from management in response to the final Loan Review Report?
Management's response to any substantive criticisms or recommendations and assess corrective actions taken.
Allowance for Loan and Lease Losses (ALLL) - Does the loan need to be Past Due to be considered impaired?
No
Allowance for Loan and Lease Losses (ALLL) - What is layering ALLL? Is it allowed per GAAP?
No, it is evaluating a loan for impairment and including it in the general allowance.
Allowance for Loan and Lease Losses (ALLL) - Are off-balance sheet items and loans held for sale included in the ALLL?
No, should maintain a separate liability account to absorb estimated off-balance estimated losses. Loans for sale are carried at the lower of cost or fair value with a separate allowance.
Oil and Gas Lending - Should probable and possible reserve receive any value when determining the borrowing base?
No, they should not receive value.
Allowance for Loan and Lease Losses (ALLL) - Is a ratio analysis sufficient basis for determining the ALLL?
No.
RE Loans - What Regulation requires banks to adopt and maintain written RE lending policies consistent with sound lending principles?
Part 365
Allowance for Loan and Lease Losses (ALLL) - When considering loan impairment, is it collateral based or performance based?
Performance based.
Commercial Loan - What do ST Working Capital and Seasonal Commercial Loans typically provide for?
Provide temporary capital in excess of normal needs.
Commercial Loan - How often should management review leveraged lending exposures?
Quarterly and provide summaries to the Board.
Independence of loan review personnel - Where should loan review personnel report their findings to?
Report directly to the Board of Directors or Board committee.
Oil and Gas Lending - How frequently should the borrowing base be reevaluated?
Semiannually
Review of Findings and Follow Up - Deficiencies that remain unresolved should be reported to who?
Senior management and BOD
Scope of Reviews - Reviews typically cover loans that are considered what?
Significant
Commercial Loan - What is Accounts Receivable Financing?
Specialized area of CML lending where borrowers assign interests in their A/R to lender as collateral. Although secured by A/R, liquidation of this collateral is typically last resort.
Commercial Loan - What oversight should be done by management for the enterprise value?
Stress-test enterprise value at origination and ongoing.
Allowance for Loan and Lease Losses (ALLL) - What is the purpose of the ALLL?
Used to absorb estimated credit losses associated with the held for investment loans and leases portfolio.
Current Expected Credit Losses (CECL) - What is the Allowance for Credit Losses (ACL)?
Valuation account that is deducted/added to the amortized cost basis of financial assets to present the net amount to be expected to be collected over the contractual term of the assets.
Commercial Loan - For Income valuation, what is discounted cash flow used for?
When cash flows are cyclical or variable over time.
Allowance for Loan and Lease Losses (ALLL) - When is a loan considered impaired?
When, based on current info and events, it is probable that the creditor will be unable to collect all interest and principal payments due according to contractual terms of loan agreement.
Allowance for Loan and Lease Losses (ALLL) - Must each bank have an ALLL?
Yes
RE Loans - Is placing undue reliance on property's appraised value in lieu of adequate initial assessment of debtor's repayment capacity a dangerous mistake?
Yes
Commercial Loan - Can Term Business Loans be used to liquidate unpaid balance of credits originally advanced for seasonal needs?
Yes it provides a way to salvage a problem situation, but could be indicative of operational problems.
Commercial Loan - Are Term Business Loans typically riskier than ST WC loans?
Yes, because it is longer term, so secured and require regular amortization.
Allowance for Loan and Lease Losses (ALLL) - Is the ALLL available to absorb losses for the entire portfolio?
Yes, not segregated for any particular loan or group of loans.
Should the Loan Officers assignment of a credit grade be subject to review?
Yes, reviews may be made by peers, superiors, loan committee, or other internal or external specialists
Is independence preferred for credit grading reviews?
Yes, since they can often provide a more objective assessment of credit quality.
Commercial Loan - Can ST Working Capital and Seasonal Commercial Loans be secured and unsecured?
Yes, typically secured by inventory and A/R
Commercial Loan - Is there greater importance for credit review to assess performance of the leveraged portfolio more frequently and in greater depth than other segments of loan portfolio?
Yes.
Should smaller banks that don't have a separate loan review department still have an effective Loan Review System?
Yes.
A Loan Review System typically includes what? 4 things.
- A formal credit grading system that can be reconciled with framework used by federal regulatory agency - Identification of loans or loan pools that warrant special attention - Mechanism for reporting identified loans to senior management and BOD - Documentation of bank's credit loss experience for various components of the loan portfolio.
Allowance for Loan and Lease Losses (ALLL) - What is Board and management's responsibility with ALLL? (4 things)
- ALLL adequacy evaluated quarterly - Establish and maintain appropriate loan review system - Ensure prompt charge-off of loans deemed uncollectable - Ensure ALLL methodology is appropriate, documented, and applied consistently.
Frequency of Reviews - How often are reviews of significant credits?
- Annually - Upon renewal - More frequently if deteriorating credit quality.
Credit Risk Rating and Grading Systems typically involve what?
- Assessment of credit quality - The identification of problem loans - Assignment of risk ratings
Commercial Loan - For Leveraged Lending, what three ways are businesses valuated?
- Asset - Income - Market
What responsibilities may be included in a Loan Review System or Credit Risk Review System?
- Assigning initial credit grades - ensuring grade changes are made when needed - compiling information necessary to assess the ALLL/ACL appropriateness
Commercial Loan - What are the two different Accounts Receivable Financing methods?
- Blanket Assignment - Ledgering the Accounts
Commercial Loan - What is the Blanket Assignment A/R Financing method?
- Borrower periodically informs the bank of A/R outstanding on books. Bank lends amount per % of A/R outstanding - Payments made from borrower to bank
Allowance for Loan and Lease Losses (ALLL) - What are the 9 Qualitative factors considered in ASC 450?
- Changes in lending policies and procedures - Changes in local and national economic and business conditions - Changes in nature and volume of the portfolio and loan terms - Changes in the experience, ability, and depth of lending management - Changes in volume and severity of PD, NA, and adversely classified loans - Changes in quality of loan review system - Changes in value of underlying collateral for collateral-dependent loans - Existence and effect of concentrations and changes in level - Effect of other external factors (legal, regulatory, competition)
RE Loans - What is considered a Real Estate Loan?
- Credit for which the purpose is purchase property OR - Any other purpose for which primary collateral protection is real property.
Depth of Reviews - Loan reviews typically analyze a number of important credit factors, including what?
- Credit quality - Sufficiency of credit and collateral documentation - Proper lien perfection - Proper loan approval - Adherence to loan covenants - Compliance with internal policies, procedures, and laws and regs - Accuracy and timeliness of credit grades assigned by LO
Scope of Reviews - Besides significant loans (predetermined size), management will normally review smaller loans that present elevated risk characteristics, such as?
- Delinquent - Nonaccrual status - TDR - Previously classified - Special Mention - Insider loans - Recently renewed credits - Loans affected by common repayment factors
Current Expected Credit Losses (CECL) - What should management consider when estimating the net amount expected to be collected?
- Effects of past events - Current conditions - Reasonable and supportable forecasts on the collectability of the bank's assets.
Commercial Loan - What are the borrower advantages of Accounts Receivable Financing?
- Efficient way to finance expanding operation - Can take advantage of purchase discounts - Ensures revolving, expanding line of credit (grows with business) - Interest payments may be no more than what would pay for comparable fixed unsecured loan.
What areas need to be addressed in a bank's Lending Policy? (17 items)
- Field/kind/types of loans the bank will engage - Lending authority of each loan officer - Lending authority of loan or executive committee - Responsibility of BOD in reviewing, ratifying, or approving loans. - Guidelines for unsecured loans - Guidelines for rates of interest and terms of repayment for secured and unsecured loans. - LTV limits and documentation required. - Guidelines for obtaining/reviewing RE appraisals and for reordering them - Maintenance and review of borrower credit files for complete/current information - Collection procedures - Loan to Asset limit - Overdraft limit - Normal trade area description - Portfolio mix goals and plans with concentration risk. - Loan review and grading system (Watch List) - ALLL guidelines - Environmental liability guidelines.
Commercial Loan - What is typically the purpose of ST Working Capital and Seasonal Commercial Loans?
- Finance seasonal requirements and repaid at end of cycle by converting inventory and A/R into cash. - Used by firms engaged in manufacturing, distribution, retailing, and service-oriented businesses.
Current Expected Credit Losses (CECL) - What does the CECL methodology not apply to?
- Financial assets measured at fair value through Net Income, including those assets for which the fair value option has been elected. - Loans held-for-sale - Policy loan receivables arising from operating leases - AFS securities (These are covered under ASC Subtopic 326-30)
Commercial Loan - What are the bank advantages of Accounts Receivable Financing?
- Higher loan yield - New business relationship or a way to keep a relationship with a customer who no longer qualifies for unsecured credit - Minimizes loss when loan is geared to a percentage of A/R collateral
Allowance for Loan and Lease Losses (ALLL) - When two factors are in the All Other Loans Allowance?
- Historical Loss - Qualitative (Environmental) Factors
RE Loans - What are the three principal indications of a troublesome RE loan?
- Improper relationship between amount of loan - Potential sale price of property - Availability of a market.
RE Loans - What are some principal errors in granting RE loans?
- Inadequate regard to normal RE values during periods when RE demand is high and prices are inflated - Lack of proper amortization - Lack of attention to max debt load and repayment capacity - Failure to restrict mortgage loans on properties with limited demand.
Allowance for Loan and Lease Losses (ALLL) - What are the general guidelines for ALLL methodology?
- Include detailed portfolio analysis - Consider ALL loans - Identify if loans will be evaluated for loss or impairment - For loss, segment portfolio into groups with similar risk characteristics - Consider all known relevant factors that impact collectability - Be applied consistently (can be modified for new factors of collectability) - Consider current collateral values (less cost to sell) if needed - ALLL functions be performed by competent and well-trained personnel - Based on current and reliable data - Well-documented and supported - Systemic and logical method to consolidate loss estimates and ensure ALLL in compliance with GAAP
Allowance for Loan and Lease Losses (ALLL) - What are the five components of ALLL?
- Individual Loan Analysis - All Other Loans Allowance - Loans/Debt Acquired with Deteriorated Credit Quality - Allowance for International Transfer Risk for Cross-Border Lending - Margin for imprecision, if needed.
Commercial Loan - What is the Ledgering the Accounts A/R Financing method?
- Lender gets a copy of invoices and lends based on that (instead of relying on bank to provide). Lend on agreed upon %. - Payments made from borrower's customers directly to the bank. Bank has complete control of funds paid on all accounts pledged.
Workpaper and Report Distribution - What does the report contain?
- List of loans reviewed - Review Date - Documentation supporting assigned ratings
Allowance for Loan and Lease Losses (ALLL) - What two ways are losses recognized?
- Loss Contingency - Impairment
Allowance for Loan and Lease Losses (ALLL) - Estimating credit losses is an imperfect practice. Examiners should generally accept management's estimates as long as they do what?
- Maintain effective systems and controls for identifying, monitoring, and addressing AQ problems in a timely manner - Analyze all significant factors that affect collectability of the portfolio - Establish an acceptable ALLL evaluation process
Allowance for Loan and Lease Losses (ALLL) - How is an impairment measured?
- PV of Discounted CFs (If not collateral dependent) - FV of Collateral (Only for collateral dependent, aka repayment is solely from sale or operation of collateral). Mus do appraised value less cost to sell. - Observable Market Value (rare)
Oil and Gas Lending - How is a Reserve-Based loan classified?
- Portion of loan secured by proved reserves classified Substandard - Any portion secured by unrisk adjusted proved reserves classified Doubtful - Any remainder that exceeds 100% of the NPV of total unrisk proved reserves should be Loss
An effective Loan Review System should address what 7 things?
- Promptly identify loans with well-defined credit weaknesses - Provide essential info for determining appropriateness of the ALLL - Identify relevant trends affecting the collectability of loan portfolio - Evaluate the activities of lending personnel - Assess adequacy of and adherence to loan policies and procedures and evaluate compliance with laws and regulations - Provide Board and senior management with objective assessment of portfolio quality - Provide management with info useful for financial and reporting purposes.
A Loan Review Policy generally addresses what 7 items?
- Qualification of loan review personnel - Independence of loan review personnel - Frequency of reviews - Scope of reviews - Depth of reviews - Review of findings and follow-up - Workpaper and report distributions
Commercial Loan - Who typically uses Accounts Receivable Financing?
- Rapidly growing businesses that need year-round funding in amounts too large for unsecured lending - Non-seasonal but need year-round funding b/s working capital and profits insufficient - Working Capital inadequate b/c volumes of sales and types of operation - Customers who previously had unsecured credits but no longer warranted because of various credit factors
Commercial Loan - What policy considerations are there for Accounts Receivable Financing?
- Requirements for operating and CF statements - Maximum amounts due from any one debtor - Definition of acceptable receivables in terms of aging, concentration, turnover - Strength of debtor accounts
Independence of loan review personnel - For small banks that can't afford a separate loan review department, what options could they have?
- Senior management independent from credit admin process - Committee of outside Directors - An outside loan review consultant
Oil and Gas Lending - What is the typical loan structure for Reserve-Based Lending?
- Typically, a revolving line of credit, reducing line of credit, or an amortizing term loan. Should amortize within the half-life of reserves. - Short-term and tied to life of asset. Reevaluate borrowing base at least semiannually with updated reserve engineering report.
Commercial Loan - What are the 4 segments of Oil and Gas Lending?
- Upstream: exploration and production - Midstream: transporting, treating, processing, storing, and marketing to Upstream companies - Downstream: refining and marketing - Support/Services: equipment, services, or support activities (drilling/water hauling)
Commercial Loan - What are characteristics of Leveraged Lending?
- Used for buyouts, acquisitions, or capital distributions - Higher than usual debt entities (Total Debt / EBITDA > 4x) - High Debt to NW ratio - Leverage ratios above industry norms.
Oil and Gas Lending - How does Reserve-Based Lending differ from Asset-Based Lending?
Differs from Asset-Based because the source of repayment in Asset-Based is the orderly liquidation of collateral in cash. Whereas, the primary source of repayment for Reserve-Based is CFs derived from extraction of Oil and Gas reserves.
Commercial Loan - What factors make Oil and Gas Lending so specialized?
Due to factors like - Global supply/demand - Geopolitical uncertainty - Weather-related issues - Fluctuations/volatility in currency markets - Changes in environmental and other government policies.
Current Expected Credit Losses (CECL) - When should CECL be implemented for non-SEC filers?
Effective fiscal years after 12/15/2022 (i.e. 1/1/2023)
Current Expected Credit Losses (CECL) - When should CECL be implemented for SEC filers?
Effective for fiscal years starting 1/1/2020.
What do the terms Loan Review System or Credit Risk Review System refer to?
The responsibilities assigned to various areas such as credit underwriting, loan administration, problem loan workout, or other areas.
Scope of Reviews - (True or False) The percentage of the portfolio selected for review should provide reasonable assurance that all major credit risks have been identified?
True.
True or False - The Board is legally responsible for formulating Lending Policies?
True. The Board should form and supervise their implementation.
Commercial Loan - Which of the 4 segments of Oil and Gas Lending has the highest credit risk and why?
Upstream and Support/Services because more affected by changes in production and commodity pricing.
Commercial Loan - For Income valuation, what is capitalized cash flow used for?
Used for stable businesses