Effective Credit Administration in Challenging Environment

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Effective Credit Administration in Challenging
Environment

• Presented by
• John Bourquard, Principal
• BKD, LLP
• September 25, 2008

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Topics Well Cover

• Todays Banking Environment
• Current Emerging Concerns
• Construction Land Development
• Practices to Improve Credit Administration

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Todays Credit Environment

• Most banks fared well through 2006
• We had experienced a small number of bank
  failures

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Todays Credit Environment

• Bear Stearns collapses
• Indy Mac fails
• Lehman Brothers largest bankruptcy in U.S.
  history
• Sale of Merrill Lynch
• AIG fights for survival
• Washington Mutual lowered to junk status

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Todays Credit Environment

• Predictions for as many as 200 banks to fail in
  next two years
• You will face some of most challenging credit
  issues you will see in your career

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Todays Credit Environment

• 2007 2008 profits
• Subprime
• Commercial real estate
• Liquidity

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Todays Credit Environment

• Commercial real estate exposure
• Construction/development national average of
  63 of capital
• December 2006 Interagency Guidance on Commercial
  Real Estate

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Todays Credit Environment

• Non-performing loans are up 68 from 6/07 to 6/08
• Delinquent construction/development loans are up
  over 300
• Classified loans are up by 44 (BKD loan review
  measure)

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Todays Credit Environment

• Loan participations
• Foreclosures construction land loans

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Todays Credit Environment

• Spring real estate market a bust
• More cautious consumer?

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Todays Credit Environment

• What drove this problem?
• Where are we headed?

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Todays Credit Environment

• Bank failures
• Douglas National Bank, Kansas City, MO, 58
  million
• ANB Financial, Benton, AR, 2.1 billion
• First Integrity, Staples, MN, 50 million
• IndyMac, Pasadena, CA, 32.0 billion
• First Heritage Bank, Newport Beach, CA, 233
  million
• First National Bank of Nevada, Reno, NV, 3.4
  billion

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Todays Credit Environment

• Bank failures
• First Priority Bank, Bradenton, FL, 259 million
• Columbian Bank Trust, Topeka, KS 622 million
• Integrity Bank, Alpharetta, GA, 1.1 billion
• Silver State Bank, Henderson, NV, 2.0 billion

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Industries of Concern

• Auto manufacturers
• Metal fabrication
• Auto dealers
• Hotels
• Restaurants

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Industries of Concern

• Contractors
• Real estate retail office
• Construction development
• Raw land holders

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Future concerns

• Agricultural loans?

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Construction Loans

• Oversupply of inventory
• Ease of entry into market
• Individual banks tolerance for specs
• Pre-sold homes
• Equity in projects

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Construction Loans

• Leverage of builders
• Losses negative/declining working capital
• Increased borrowing against inventory
• Inventory declines, but bank debt declines less
• Stretching trade
• Continuing to build can generate cash

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Construction Loans

• Inspection of properties
• Lending against stored or ordered materials
• Quality of fixtures, trim, etc. on homes being
  completed today
• Landscaping
• All funds advanced with work still to be
  completed

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Land ( Condo) Development

• Nature of subdivisions condos project
  financing
• Basis for valuation bulk sales value or net
  present value of future cash flows
• Drivers of this value today

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Land ( Condo) Development

• Example 100 lots at 75,000/lot, two year
  sellout 15 discount rate 7.5 million retail
  value, but 6.4 million bulk sales value
• Example 100 lots at 75,000/lot, five year
  sellout 15 discount rate 7.5 million retail
  value, but 5.2 million bulk sales value

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Land ( Condo) Development

• Absorption rate of existing home inventory has
  big impact on value of land developments
• Issue how will interest reserve be replenished
  going forward?
• Issue will borrower be required to reduce
  loan/value ratio for renewals?

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Raw Land

• Value is very volatile
• Current home inventory current developed lots
  have to sell
• Will someone pay appraised value today?

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Improving Credit Administration

• This is where you control risk

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Improving Credit Administration

• Appropriate number of satisfactory risk grades
• Use of Satisfactory/Watch Special Mention
• Grade your portfolio objectively
• Guarantor reliance how much is too much?

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Improving Credit Administration

• Monitor your classified assets/capital ratio
  project your trend
• Understand all costs on front end of project
• Ensure your borrower has equity in project
  keeps it there

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Improving Credit Administration

• On speculative land construction projects,
  where will repayment come from?
• For subdivision condo developments,
  continuously re-project cash flow. Understand
  how you will be repaid!
• For construction/development loans, ask for
  interest reserves loan reductions as appropriate

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Improving Credit Administration

• Monitor financial statement exceptions by loan
  officer by time of year
• Borrowing bases have supporting information
• Look closely at receivable agings
• Avoid paid as agreed trap!!!!!!!

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QUESTIONS?

• Please call anytime with questions
• John Bourquard
• BKD, LLP
• 317.383.3783
• jbourquard_at_bkd.com