Loan Valuation Using Present Value Analysis - FDIC

8/17/2019 Loan Valuation Using Present Value Analysis - FDIC

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LOAN VALUATION USINGPRESENT

VALUE ANALYSIS

William Thomas

U.S. Department of Treasr!O"#e of Te#hni#al Assistan#e


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OVERVIEW This presentation covers loan classifcation

and present value calculations used in the

valuation o loans. Loan valuation is used or analyzing decisions

regarding perorming, sub-perorming and non-perorming loans.

Present value calculations, which include theanalysis o ris and the time value o money,are re!uired when asset disposition decisionshave to be made.


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S%%este& Poli#!

Proper credit decisions re!uire theevaluation o collection alternatives on acomparable basis. Thereore, it should bethe policy o LP" to employ present value

techni!ues to assist in determiningcourses o action most advantageous toLP" in the li!uidation o closed banloans.


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What is Present ValeAnal!sis'

#et present value$

#P% compares the value o a dollar today tothe value o that same dollar in the uture,

taing in&ation and returns into account. ' the #P% o a prospective collection

e(ceeds the involuntary worst-casescenario, it should be accepted.

' #P% is negative, the o)er should probablybe re*ected because cash &ows are lessthan the worst case.


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Present value$

The current worth o a uture sum o money or stream ocash &ows given a specifed rate o return

+uture cash &ows are discounted at the discount rate, and

the higher the discount rate, the lower the present value othe uture cash &ows.

etermining the appropriate discount rate is the ey toproperly valuing uture cash &ows, whether they be earningsor obligations.

lso reerred to as discounted value.

Put simply the basis is that receiving /0,111 now is worthmore than /0,111 fve years rom now, because i you gotthe money now, you could invest it and receive an additional

return over the fve years.


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Time value o money$ The concept that money available at

the present time is worth more thanthe same amount in the uture due toits potential earning capacity.

This core principle o fnance holds

that, provided money can earninterest, any amount o money isworth more the sooner it is received.


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Loan (lassi)#ation

Determinin% loan stats 's the loan perorming, sub-perorming or non-perorming2

Performin% Loan

Paying as agreed 3less than 41 days past due5 6(pected to pay in ull under the terms o the note #o serious past delin!uency or fle documentation

problems

S*+Performin% Loan

The borrower is presently perorming but is ultimatelypro*ected to deault due to a severe negative event in theuture7aturity with balloon payment due

7a*or tenant move-out

Loss o other ma*or customer


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Loan (lassi)#ation

Non+Performin% 41 days or more past due

Past the note or modifcation maturity date

8egardless o whether the borrower is maing

payments


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Valation of Performin% Loans

Valation Usa%e #ormally the frst step in establishing a reserve price when

selling to the secondary maret.

lso used to get borrowers to refnance by creating adiscounted value.

8efnancing should be encouraged or perorming loans withe(tended maturities that are not readily saleable or when themaret or a particular type o loan is limited.

,ar-et Vale Perorming loan value is calculated through a 7ar-to-7aret

process in which the remaining payments are present valuedusing current maret yield re!uirements or similar loans. Theresult o this discounting is called the Market Value.


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Valation of Performin% Loans

,ar-et Rate Perorming loan maret value is calculated by using a current

maret yield or similar types and !uality o loans.

The current maret yield is comprised o a base rate, which isthe rate or good !uality, maret-standard loans, ad*usted or

the characteristics o specifc loans.

ase Rate 7ay be well defned or loans such as residential mortgages.

n estimation may be re!uired or loans with uni!ue terms.

7ay be determined through recognized publications or through

surveys o local lending institutions.

These surveys should be recorded and updated periodically.


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Valation of Performin%

Loans

A&/stin% the ase Rate "pecifc loan actors can a)ect the base rate. These

are determined by reviewing the loan fle 3duediligence.5

Past delin!uency history

ocumentation defciencies

9eographic location i the base rate does not re&ect locallending practices.

The current maret yield is the result o ad*usting thebase rate or any o these actors.


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Valation of Performin%Loans

A&/stin% the ase Rate :ere are some sample standardized ad*ustments used by the +';

in valuing perorming loans$

,issin% Do#mentation A&/stments

11bp

+inancial statement 011bp

;redit fle 3including +="5 411bp

(re&it

7ore than 41 days delin!uent > or more >11bp

times in the past year


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Valation of Performin%

Loans

A&/stin% the ase Rate

;urable documentation defciencies, such as a missingappraisal, should not be included in the standardad*ustments.

"ometimes it is more advantageous not to cure suchdefciencies, though in this case, yield ad*ustmentsshould be made.

d*ustments or curable defciencies should not e(ceed011bp.


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Valation of S*+Performin%an& Non+Performin% Loans

Present Vale ,etho&olo%! #et Present %alue o the 6stimated ;ash 8ecovery 3#P%-

6;85

?ased on a li!uidation scenario

6stablished by estimating, over time, ;ash recoveries

irect e(penses

Payment o any prior liens

6stimated net cash &ows are then present valued using anappropriate discount rate

This rate re&ects the ris associated with$

The sources o the ultimate collection

The estimated timing o the cash &ows


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Valation of S*+

Performin% an& Non+Performin% Loans

Li0i&ation S#enario ecisions on a compromise, restructure or sale are

based on the same established value.

?roadly defned as the cash &ows rom$

+oreclosure=repossession, holding and sale o collateral.

;ollection through litigation rom identifable assets o theborrowers or guarantors.

+or sub-perorming loans, #P%-6;8 may also includepro*ected principal and interest payments until deault

occurs.


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Anal!1in% Alternati2es The li!uidation scenario is essentially the worst-case

scenario

't should be used as a base-line in comparing otheroptions, particularly a cash o)er by the borrower tocompromise the debt.

The cash o)er should have present value analysisperormed at a realistic discount rate, actoring in down

payment and perceived ris actors. This helps provide or a realistic counter-o)er to the

borrowers proposal and ultimately to *ustifcation oraccepting the settlement or less than payment in ull.


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To #al#late the NPV+E(R3 Pro*ect !uarterly cash &ow estimates or the frst two

years, and annually thereater.

Pro*ect cash &ows starting rom the time the estimate ismade.

+irst !uarter recoveries are those estimated to occur within@1 days, second !uarter between @0 and 0A1 days, etc.

iscount all cash &ows !uarterly, even i they are beyond

the frst two years. P% calculations assume all cash &ows occur at the end o

the period in which they are estimated.

6;8 cannot e(ceed total principal and interest due.


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Pro/e#tion of (ash 4lo5s

Sor#es of Re#o2er! Bhen estimating cash &ows, consider all potential

sources o recovery, including$ ;ollateral

?ased on current appraisals 8ecognized publications "hould be based on current values and not actoring in

pro*ected or e(pected uture maret changes


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Sor#es of Dire#t E6penses Type and amount vary by sources o recovery and

collection laws +or #P%-6;8, direct cash collection e(penses include

items such as$ Legal ees dvances to protect asset 3property ta(, insurance, etc.5 Payment o prior liens

+oreclosure costs "elling e(penses

ppraisal ees


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In&ire#t E6penses

#o deduction should be made or indirect e(penses suchas the LP"Cs internal overhead or administrative costso doing business.


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Timin% of (ash 4lo5s

The timin% of estimate& #ash re#o2eries an&e6penses &epen&s on3 8epossession and oreclosure law

Litigation and banruptcy scenarios 6stimated selling time or oreclosed collateral 6(ample$

' the oreclosure taes 4 months and holding period is si(months, then the recovery is pro*ected in the third !uarter

The cash recovery is listed at the time o sale, not the timeo oreclosure

6(penses should be placed in the periods in which theyare e(pected to occur.

LP" could standardize certain time rames, such asoreclosure, repossession and holding periods or di)erent

types o collateral


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When to Get Le%alAssessment

When a pro/e#te& re#o2er! is *ase& on the0estiona*le ot#ome of a #ort &e#ision3 The #P%-6;8 should re&ect counselCs assessment o

probable success

n outcome is !uestionable when the probability is less thanDEF

The probability o success percentage provided by counsel

should be applied only to those cash &ows resulting rom asuccessul outcome

't would not a)ect any recoveries or e(penses prior to orunrelated to the court decision

' the probability is DEF or greater, no ad*ustment should be

made


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Do#mentation

The &o#mentation re0ire& to estimatere#o2eries &epen&s on the si1e an& t!pe ofloan3 +or very small loans, estimated recoveries may be based

on e(isting inormation and credit inormation ;ertain mortgage loans may only re!uire an appraisal to

calculate #P%-6;8 +or larger loans e)orts should be made to obtain

documentation to establish the recovery estimate

;ollateral appraisals, asset and lien searches, credit reports,fnancial statements, etc.

The collectorCs personal eelings about the debtor orcollectibility should not be actored in


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Dis#ont Rates

,easrin% Ris- iscount rates used to present value the #P%-6;8

measure the potential ris associated with$

"ources o recovery

The timing o the pro*ected cash &ows

n appropriate return on investment to LP" or a purchaser

+or e(ample$

Less ris should be associated with estimating recovery ona perorming mortgage loan with a current appraisal thanon an unsecured loan without current fnancialinormation.


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Dis#ont Rates

Dis#ont Rates for NPV+E(R :ere are some sample discount rates used to present

value the #P%-6;8 that were utilized by the +';$

Sor#es of E(R Dis#ont Rate

t least >1F o total 6;8 rom Prime G E

8eal 6state ;ollateral

Less than E1F o total 6;8 rom Prime G D8eal 6state ;ollateral

6;8 entirely rom sources other than Prime G 01

8eal 6state ;ollateral 3includes

Hnsecured loans5

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Loan Valuation Using Present Value Analysis - FDIC