Strategies Used by the Banking Industry Essay Example for Free

Strategies Used by the Banking Industry EssayIn depressed economic times, Banking is an industry that is prone to substantial pecuniary losses, from customers closing their depository account to an increase in outstanding impart delinquency. An increase in consumer and commercial give defaults seat disability the integrity of a Banks outstanding lend portfolio. Such deterio balancen can lead to an increase of Non-Performing Assets.Once a loan is non execute, (usually when a debtor has not made their scheduled payment for at least 90 days, but there atomic number 18 other reasons why a loan can be deemed non-performing) the odds that it impart be repaid in full are considered to be substantially lower. The non-performing asset is therefore not yielding any income to the lender in the form of principal and interest payments.Banks have spent the last several yrs grappling with nonperforming assets, but perhaps working out problems with bad loans is best left to entities that do not have to answer to a Federal Regulator. This year, more bounds have escalated efforts to sell nonperforming assets, and industry experts say the spate of such deals is only going to increase. Meanwhile, a new deal structure is calling for sellers to retain the problematic assets to work them out on their own. (Barba, 2011)But, even if a loan pays in accordance with its Terms Conditions, it still can be categorized non-performing for several reasons. Deterioration in financial ratios can cause a loan to be classified non-performing, one of those financial ratios is give to Value or LTV.LTV is the outstanding principal balance of the loan divided by the appraised cherish for real property pledged as collateral for a loan. When the appraised value of the pledged collateral decreases faster than the principal of the loan, the LTV will increase, thereby making this loan a greater risk in case of default.The benchmark LTV ratio will usually not exceed 75%, the rationale be hind this doorsill is if the loan does default and, subsequently, the asset disposed of, that the 25% of equity can be used to reimburse the avow for legal fees, court cost, and expenses incurred with liquidating the collateral. This strategy is compound in the banks lending policy in the effort to make the bank whole in a loan default scenario.When the loan request is not collateral based, the key financial ratio used to determine the borrowers ability to repay is Debt Service Coverage or DSC. This ratio is calculated using the existing company debt, plus the new loan obligation, divided by the businesses existing cash flow to determine if the total debt can be supported. Covenants in the loan documentation will require the business to furnish Tax Returns and Financial Statements annually to review the borrowers financial watch to ensure sufficient DSC. If it is determined that the DSC is not sufficient or if the borrower is not in compliance of the Loan Covenant by not supplyi ng the infallible financial information, the loan can be classified as non-performing.An increase in the level of non-performing assets increases risk and impacts capital levels that regulators believe are appropriate in light of the ensuing risk in the loan portfolio. Regulators request that the level of non-performing assets be reduced. If these problem assets are not reduced through loan sales, workouts, or restructuring or the level of problem assets continue to rise through decreases in the value of the underlying collateral, or in these borrowers performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect the banks operations and financial condition. This is why banks are so raise in getting these assets off the books.Banks thatve held on to some loans in hopes of a rapidly increasing economic recovery are starting to lose hope. Moreover, the Euro geographical zone Debt Crisis and, locally, the $1.2 bil lion dollar debacle and former New Jersey Governor Jon Corzines MF Global, plus the decline in Moodys index of commercial property values, which reached virtually 200 in late 2007 and early 2008, before taking a complete round trip back to 100 as of the beginning of this year and leveling off to about 120but has been largely treading water since late 2009. After that bounce, its gone back down a little, and looks to be straightaway for the foreseeable future, says David Tobin, one of the two principals of Mission Capital Advisors. Its a smart time to sell. (McDonald, 2011)Another reason for the converted interest in selling these assets is the gainsay that banks are having in making new loans. Analysts and investors are demanding balance sheet improvements out of the banks, says Tobin, and if the banks cant show strength by adding new, solid loans, wherefore theyll do it by unloading legacy assets that are a drag on capital. And thats just what has happened. But when they can se ll, they do. The best thing a bank can do is sell properly marked assets that help fix the balance sheet. The more you can sell, the better you are perceived. says Tobin. (McDonald, 2011).So, how do banks dispose of these assets and what is done with those assets that cannot be sold on a Secondary Market? There are several loss mitigation alternatives used by banks in both scenarios.Typical Strategies used in the sale of non-performing loans are usually Note Sales, Short-Sale or Short-Payoffs, or a Deed in office of Foreclosure. A Note Sale is just as it sounds. A Bank will assign all its rights and interests in the subject Note and Mortgage (or a group of Notes and Mortgages) to an interested party for an appropriate price.A Short-Sale or Short-Payoff, again, is just as it sounds, is a method whereby the bank examines the value of the collateral, financial condition of the borrower, and will determine the amount of acceptable loss that the bank would be willing to incur just to ma ke the borrower go away instead of involving themselves in a, potentially, elongated Foreclosure process.Lastly, the Deed in Lieu of Foreclosure is the process whereby the borrower surrenders the Title to the property instead of going through the, potentially lengthy and expensive, Foreclosure process. This method allows for the bank to receive a maximum price for the collateral since they, in essence, are owners of the property since they are in possession of the Title and the buyer does not have to take subsidisation in any Legal action initiated by the bank. More often than not, with this option, borrowers will also insist on the release of any in-person guarantors on the Mortgage, so the bank doesnt have an option of pursing any potential deficiency balance on the loan after the sale of the collateral.When a bank cant sell their criticized and classified loans on the secondary market and has no other choice that to keep those loans on their books, there are several methods th at can be used to modify the existing impairment and conditions of a loan to, possibly, strengthen the point of reference in hopes of a possible heighten in the loans classification by the banks Risk Managers.The first (and most preferred) of these methods is the Reinstatement. The borrower will pay all loan arrears (past-due Principal and wager) and continue salaried as agreed through the term of the loan. As an incentive to the borrower, the bank has the option of waiving accrued Late Charges and Default Interest amounts as part of the terms of the agreement. Typically, if the loan performs as agreed (usually for six to twelve months) after reinstatement, the banks Risk Managers will agree to re-classify the loan back to a performing status and resume taking in the interest income on the loan.The remaining methods are several types of Forbearance Agreements. A Standard Forbearance is often thoughtfulness (the banks delay in enforcing its legal rights and remedies under the N ote) for a promise by the debtor to pay an added amount to the current Principal and Interest payments to cure the loan arrears. A Refinance Forbearance is an option whereby the borrower intends to refinance their loan with the bank in order to satisfy the obligation. Lastly, a Graceful blend in Forbearance allows the borrower the time to market and sell the mortgaged premises in order to satisfy the underlying loan obligation to the bank. The time allowed by the bank in any forbearance scenario will, usually, not exceed twenty four months.In good times or bad, deciding how to manage nonperforming assets is never easy. Loan workout can be intricate and costly, both in time and resources spent on deciding whether to work out an asset or heighten on what can be salvaged. Moreover, it also requires the bank to evaluate whether the borrower can recover and still remain valued customer. (Trauner 2009) But, if the decision is made to sell the credit, then the decision is how to maximize the consideration received for the asset. Selling assets can often be perplexing and nerve-racking and the reality is that if you take time to evaluate and signify purposefully about your portfolio, selling these assets can be a very effectual and fruitful tool to help manage your portfolio through the ups and downs in credit cycles. (Trauner 2009)REFERENCESBarba, R. (2011, November 14). Toxic assets turn into opportunity for community banks. Retrieved from http//www.americanbanker.com/issues/176_221/loan-sales-nonperforming-assets-private-equity-1044055-1.html. (Barba, 2011)McDonald, D. (2011, November 04). Good news? Its a buyers market for bad loans. Retrieved from http//finance.fortune.cnn.com/2011/11/04/bank-bad-loans/ (McDonald, 2011)Trauner, S. (2009, April). Non-performing assets The keep versus sell decision. Retrieved from http//www.wib.org/publications__resources/article_library/2009-10/mar09_assets.html (Trauner, 2009)