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William Thomas
U.S. Department of Treasury
Office of Technical Assistance

This presentation covers loan classification
and present value calculations used in the
valuation of loans.

Loan valuation is used for analyzing decisions

regarding performing, sub-performing and nonperforming loans.
Present value calculations, which include the
analysis of risk and the time value of money,
are required when asset disposition decisions
have to be made.

Suggested Policy
Proper credit decisions require the
evaluation of collection alternatives on a
comparable basis. Therefore, it should be
the policy of LPS to employ present value
techniques to assist in determining
courses of action most advantageous to
LPS in the liquidation of closed bank

What is Present Value

Net present value:
NPV compares the value of a dollar today to
the value of that same dollar in the future,
taking inflation and returns into account.
If the NPV of a prospective collection
exceeds the involuntary worst-case
scenario, it should be accepted.
If NPV is negative, the offer should probably
be rejected because cash flows are less
than the worst case.

What is Present Value

Present value:
The current worth of a future sum of money or stream of
cash flows given a specified rate of return
Future cash flows are discounted at the discount rate, and
the higher the discount rate, the lower the present value of
the future cash flows.
Determining the appropriate discount rate is the key to
properly valuing future cash flows, whether they be earnings
or obligations.
Also referred to as "discounted value".
Put simply the basis is thatreceiving $1,000 now is worth
more than $1,000 five years from now, because if you got
the money now, you could invest it and receive an additional
return over the five years.

What is Present Value

Time value of money:

Theconcept that money available at

the present time is worth more than
the same amount in the future due to
its potential earning capacity.
Thiscore principle of finance holds
that, provided money can earn
interest, any amount of money is
worth more the sooner it is received.

Loan Classification
Determining loan status

Is the loan performing, sub-performing or non-performing?

Performing Loan

Paying as agreed (less than 30 days past due)

Expected to pay in full under the terms of the note
No serious past delinquency or file documentation

Sub-Performing Loan

The borrower is presently performing but is ultimately

projected to default due to a severe negative event in the
Maturity with balloon payment due
Major tenant move-out
Loss of other major customer

Loan Classification

30 days or more past due

Past the note or modification maturity date
Regardless of whether the borrower is making

Valuation of Performing Loans

Valuation Usage

Normally the first step in establishing a reserve price when

selling to the secondary market.
Also used to get borrowers to refinance by creating a
discounted value.
Refinancing should be encouraged for performing loans with
extended maturities that are not readily saleable or when the
market for a particular type of loan is limited.

Market Value

Performing loan value is calculated through a Mark-to-Market

process in which the remaining payments are present valued
using current market yield requirements for similar loans. The
result of this discounting is called the Market Value.

Valuation of Performing Loans

Market Rate

Performing loan market value is calculated by using a current

market yield for similar types and quality of loans.
The current market yield is comprised of a base rate, which is
the rate for good quality, market-standard loans, adjusted for
the characteristics of specific loans.

Base Rate

May be well defined for loans such as residential mortgages.

An estimation may be required for loans with unique terms.
May be determined through recognized publications or through
surveys of local lending institutions.
These surveys should be recorded and updated periodically.

Valuation of Performing

Adjusting the Base Rate

Specific loan factors can affect the base rate. These

are determined by reviewing the loan file (due
Past delinquency history
Documentation deficiencies
Geographic location if the base rate does not reflect local

lending practices.

The current market yield is the result of adjusting the

base rate for any of these factors.

Valuation of Performing

Adjusting the Base Rate

Here are some sample standardized adjustments used by the FDIC

in valuing performing loans:

Missing Documentation Adjustments

Original note/credit agreement
Financial statement
Credit file (including F/S)
More than 30 days delinquent 2 or more
times in the past year


Valuation of Performing

Adjusting the Base Rate

Curable documentation deficiencies, such as a missing

appraisal, should not be included in the standard
Sometimes it is more advantageous not to cure such
deficiencies, though in this case, yield adjustments
should be made.
Adjustments for curable deficiencies should not exceed

Valuation of Sub-Performing
and Non-Performing Loans
Present Value Methodology

Net Present Value of the Estimated Cash Recovery (NPVECR)

Based on a liquidation scenario
Established by estimating, over time,

Cash recoveries
Direct expenses
Payment of any prior liens

Estimated net cash flows are then present valued using an

appropriate discount rate

This rate reflects the risk associated with:

The sources of the ultimate collection
The estimated timing of the cash flows

Valuation of SubPerforming and NonPerforming Loans

Liquidation Scenario

Decisions on a compromise, restructure or sale are

based on the same established value.
Broadly defined as the cash flows from:
Foreclosure/repossession, holding and sale of collateral.
Collection through litigation from identifiable assets of the

borrowers or guarantors.
For sub-performing loans, NPV-ECR may also include
projected principal and interest payments until default

Valuation of Sub-Performing

and Non-Performing Loans

Analyzing Alternatives

The liquidation scenario is essentially the worst-case

It should be used as a base-line in comparing other
options, particularly a cash offer by the borrower to
compromise the debt.
The cash offer should have present value analysis
performed at a realistic discount rate, factoring in down
payment and perceived risk factors.
This helps provide for a realistic counter-offer to the
borrowers proposal and ultimately to justification for
accepting the settlement for less than payment in full.

Valuation of Sub-Performing

and Non-Performing Loans

To calculate the NPV-ECR:

Project quarterly cash flow estimates for the first two

years, and annually thereafter.
Project cash flows starting from the time the estimate is
First quarter recoveries are those estimated to occur within
90 days, second quarter between 91 and 180 days, etc.
Discount all cash flows quarterly, even if they are beyond
the first two years.
PV calculations assume all cash flows occur at the end of
the period in which they are estimated.
ECR cannot exceed total principal and interest due.

Projection of Cash Flows

Sources of Recovery

When estimating cash flows, consider all potential

sources of recovery, including:

Based on current appraisals

Recognized publications
Should be based on current values and not factoring in
projected or expected future market changes

Other attachable or recoverable assets of borrowers and


More subjective and should be very conservative

Based on:
Financial statements
Credit reports
Asset searches and legal depositions

Projection of Cash Flows

Sources of Direct Expenses

Type and amount vary by sources of recovery and

collection laws
For NPV-ECR, direct cash collection expenses include
items such as:
Legal fees
Advances to protect asset (property tax, insurance, etc.)
Payment of prior liens
Foreclosure costs
Selling expenses
Appraisal fees
Operating Expenses
Management fees
Other direct expenses not listed here

Projection of Cash Flows

Indirect Expenses
No deduction should be made for indirect expenses such
as the LPSs internal overhead or administrative costs
of doing business.

Timing of Cash Flows

The timing of estimated cash recoveries and

expenses depends on:

Repossession and foreclosure law

Litigation and bankruptcy scenarios
Estimated selling time for foreclosed collateral
If the foreclosure takes 3 months and holding period is six

months, then the recovery is projected in the third quarter

The cash recovery is listed at the time of sale, not the time
of foreclosure

Expenses should be placed in the periods in which they

are expected to occur.
LPS could standardize certain time frames, such as
foreclosure, repossession and holding periods for different
types of collateral

When to Get Legal


When a projected recovery is based on the

questionable outcome of a court decision:

The NPV-ECR should reflect counsels assessment of

probable success
An outcome is questionable when the probability is less than
The probability of success percentage provided by counsel
should be applied only to those cash flows resulting from a
successful outcome
It would not affect any recoveries or expenses prior to or
unrelated to the court decision
If the probability is 75% or greater, no adjustment should be


The documentation required to estimate

recoveries depends on the size and type of


For very small loans, estimated recoveries may be based

on existing information and credit information
Certain mortgage loans may only require an appraisal to
calculate NPV-ECR
For larger loans efforts should be made to obtain
documentation to establish the recovery estimate
Collateral appraisals, asset and lien searches, credit reports,

financial statements, etc.

The collectors personal feelings about the debtor or
collectibility should not be factored in
Obtaining such information can often increase the valuation of
the loan and outweigh the cost of gathering the information

Discount Rates

Measuring Risk

Discount rates used to present value the NPV-ECR

measure the potential risk associated with:
Sources of recovery
The timing of the projected cash flows
An appropriate return on investment to LPS or a purchaser

For example:
Less risk should be associated with estimating recovery on

a performing mortgage loan with a current appraisal than

on an unsecured loan without current financial

Discount Rates

Discount Rates for NPV-ECR

Here are some sample discount rates used to present

value the NPV-ECR that were utilized by the FDIC:

Sources of ECR Discount Rate

At least 20% of total ECR from Prime + 5
Real Estate Collateral
Less than 50% of total ECR from
Real Estate Collateral
ECR entirely from sources other than
Real Estate Collateral (includes
Unsecured loans)

Prime + 7

Prime + 10