Dimension 6 - 20 to 37 PDF

DIMENSION 6 - 20 NOTES: KEY RISKS The major risks associated with bridge loan financing include: The asset is not sold at the price anticipated or by the expected deadline. The asset was not valued correctly at the time the loan was made, or has deteriorated in value due to mismanagement or changing...

DIMENSION 6 - 20 NOTES: KEY RISKS The major risks associated with bridge loan financing include: The asset is not sold at the price anticipated or by the expected deadline. The asset was not valued correctly at the time the loan was made, or has deteriorated in value due to mismanagement or changing market conditions. Prospective buyers of the asset disappear through changes in market conditions, inability to raise financing, or the appearance of unexpected contingencies such as legislative or environmental changes. The debt or equity markets have deteriorated due to changes in the economy. These risks are mitigated by a careful analysis to ensure a strong cash flow of the company or project as a secondary source of repayment for the loan. MORTGAGE FINANCING GENERAL FEATURES CRC US Body of Knowledge Mortgage financing is generally a long-term loan that provides the lender with a lien on property as security for the repayment of the loan. The company has use of the property and the lien is removed when the obligation is fully paid. A mortgage generally involves real estate. For property such as machines, equipment, or tools, the lien is called a chattel mortgage. Lenders will generally allow a loan as a percentage of property market value of as much as 75–80%, depending on the property and market. In the event of default, this advance percentage allows the lender a margin of error on market value and selling expenses. DIMENSION 6 - 21 The purpose of mortgage financing is to provide funds for the acquisition or refinance of real property. Financial institutions may finance the acquisition, construction, or refinance of real property that is: Income producing; i.e., office buildings, shopping centers, hotels, etc. Owner-occupied property for use in the owner’s direct day-to-day business operations. COLLATERAL CONSIDERATIONS The lender will take a security interest in the property being financed as well as an assignment of rents and leases. Other collateral may be taken as an abundance of caution. SOURCE OF REPAYMENT In the case of property of a business or owner-occupied real estate, the primary source of repayment is the cash flow from the business. In addition, the value of the asset being financed may provide a second way out of the loan. In the case of investment property, a careful analysis of the cash flow provided by the tenant leases will be key to repayment. The overall marketability of the asset through liquidation provides a second way out. KEY RISKS The key risks in mortgage financing are: The initial accuracy of the asset valuation and the continued maintenance of the value of the underlying asset. The strength and maintenance of the underlying cash flows of the asset. The mitigants to these risks are to ensure, through careful monitoring, that the asset value and cash flow are maintained. In the event that the asset value falls below the required percentage of the loan value, the lender should request additional collateral or a reduction in the loan principal through prepayment. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. LOAN PURPOSE DIMENSION 6 - 22 NOTES: SPECIAL PROGRAMS In addition to direct lending through financial institutions, many banks participate in state and federal programs that provide financing to companies. These programs are designed to get business and government to work together toward improving the economic development of the community. Several programs will be noted below, but you are encouraged to research information in your area for statespecific programs. The U.S. Small Business Administration has a comprehensive program of services to help small business owners and potential entrepreneurs. Through the loan guaranty program, the SBA provides short and long-term loans to eligible, credit-worthy start-up and existing small businesses that cannot obtain financing on reasonable terms through normal lending channels. Loan guaranties, not direct loans, are provided through participating financial institutions. Other programs provided through the SBA include: Investment programs providing equity capital to small businesses. Surety bond guarantee program for small businesses that cannot obtain surety bonds through regular commercial channels. Business counseling and training. Disaster assistance. Assistance for armed forces veterans. Assistance for exporters. Assistance for minorities in business. CRC US Body of Knowledge For more detailed information on any of these programs, contact your local SBA office or visit their website at http://www.sba.gov/. Industrial revenue bond financing involves the issuance of tax-exempt bonds by a public entity including a city, county, development authority, or state for one of the following purposes: To finance the acquisition, construction, rehabilitation, improvement, equipping, and/or furnishing of facilities for qualifying companies. To refinance outstanding tax-exempt bonds. DIMENSION 6 - 23 Expanding or rehabilitating their facilities. Constructing new facilities. Acquiring new facilities or equipment. Relocating into the community. Below are some of the programs that are available: Small Issue Industrial Revenue Bonds to finance manufacturing facilities costing less than $10 million. Enterprise Zone Facility Bonds to finance retail, commercial, and manufacturing businesses in certain zones for up to $3 million per area. 501C(3) Bonds provide financing for nonprofit companies for assisted living or nursing home facilities. Refunding Bonds are issued to refinance projects originally financed with any of the above programs. You will need to contact your local authority for more information on eligibility for these programs. SUBORDINATED DEBT GENERAL FEATURES Subordinated debt is usually placed for a longer-term (7–12 years) than senior debt and interest is payable at a fixed rate. It is sometimes referred to as mezzanine debt if there are equity warrants or convertible features attached to the subordinated debt. An equity warrant entitles the holder at some specified or unspecified point in the future to buy a proportionate amount of common stock at a specified price and is issued with the debt. A convertible corporate security is exchangeable for a set number of another form of corporate security at a pre-stated price. For example, subordinated debt may be converted into common shares that generally provide a higher return. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. Industrial revenue bonds can be a cost-effective alternative for manufacturing companies, non-profit corporations, and real estate developers who are: DIMENSION 6 - 24 NOTES: Therefore, in addition to receiving the interest on the debt, the holder of subordinated debt may have rights to future equity ownership of the company. This brings the overall return higher than the stated interest rate on the debt. The usual providers are insurance companies, pension, and investment funds, or other long-term investors. Principal provisions in subordinated debt may include: In insolvency or bankruptcy, the senior lender (who has first priority claim on the company’s assets) will be paid out before the subordinated lender receives any payment. Payments of the subordinated debt (principal or interest) are prohibited if the senior debt is in default. No principal payments are scheduled on the subordinated debt until after final maturity on the senior debt. The senior lender will often seek the right to have all penalties, fees, and expenses of collection paid before the subordinated lender gets any payment. LOAN PURPOSE The funds are used to finance the long-term needs of the company, including acquisitions, purchase of equipment or fixed assets, support permanent working capital, and refinance debt or equity, particularly in situations where a term longer than 5–7 years is needed or flexible amortization schedules may be required. Typically, 15% to 30% of acquisition financing is in the form of subordinated financing. CRC US Body of Knowledge COLLATERAL CONSIDERATIONS Subordinated debt is usually unsecured or secured by junior liens (subordinate in bankruptcy claims) on the assets. In some cases, the lending institution may be granted stock options to own equity in the business as a sweetener to enhance the marketability of the debt and improve the overall return on the debt. SOURCES OF REPAYMENT The repayment structure of subordinated debt should be closely linked to the cash flows of the company. This layer of debt is appropriate in situations where cash flows will be generated over a longer period of time than traditional term debt allows. Recapitalizations or restructurings, significant capital expenditures, and acquisitions are examples of subordinated debt applications. DIMENSION 6 - 25 The key risks associated with subordinated debt financing are: Subordinated debt is considered quasi equity by the company’s creditors because it stands behind other debt in the event of liquidation. Subordinated debt is usually unsecured or at least has junior liens on the company’s assets. Pricing of subordinated debt is usually higher than for senior debt, which adds extra debt service burdens on the company’s cash flows. These risks can best be mitigated by: Clearly understanding and accepting the risk and unsecured nature of issuing subordinated debt. Ensuring that the company exhibits sufficient operating cash flow to comfortably service all debt including the subordinated debt. Limiting the amount of senior debt and trade credit that the company can incur while the subordinated debt is in place. Establish a firm payout strategy for the subordinated debt that has a reasonable assurance of occurring. If you are a senior lender to a company with subordinated debt in place, you should carefully read and understand the terms and conditions of the subordinated debt on your customer’s books. All subordinated debt is different and its terms and conditions should be compatible with the structure of your customer’s senior debt. Since it stands behind other debt in liquidation, subordinated debt is generally considered to be quasi-equity. Other lenders may be willing to extend additional credit to the company as though the subordinated debt did not exist, as long as their debt is repaid first. Based on the long-term, generally unsecured nature of this debt, the risks can be greater than for senior debt. Pricing is higher than senior debt (usually 2% to 8% over senior debt), and covenants are generally required. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. KEY RISKS DIMENSION 6 - 26 NOTES: PRIVATE PLACEMENTS GENERAL FEATURES Another source of funds for companies is through a private placement. A private placement is the sale of debt or equity to a private or institutional investor, including individuals, insurance companies, pension funds, and investment companies. The issuance does not have to be registered with the Securities Exchange Commission and must be purchased for investment, not resale. The bank matches the company’s capital needs with institutional investors who provide the financing. The bank’s role is one of agent and arranger. Financing that is arranged through private placements can include: Senior term loans. Subordinated debt. Debt with equity enhancements such as warrants. Common and preferred stock. The structure of a debt private placement covers the full range of options: Secured or unsecured. Fixed or floating rates. Medium to long term. Varying amortization schedules. CRC US Body of Knowledge Note: Rule 144A private placements are eligible for secondary sale to qualified institutional buyers, increasing the liquidity of the private placement market. These issues are particularly convenient for international issuers, and they can be used for both investment-grade and non-investment-grade issuers. Generally, the size of the transactions is $3 million or more for equity/ mezzanine debt and $10 million or more for senior debt, with terms ranging from 3 to 15 years, with some extending to 30 years. For the investor providing the funds, pricing for fixed-rate debt is generally 60 to 300 basis points over comparable U.S. Treasuries. The type and number of financial covenants will vary according to the issuer’s or company’s credit quality and general market conditions. Mezzanine issues (debt with equity enhancements) require coupons of 9% to 12% with an equity component yielding an all-in return of 13% to 23%; preferred and common stock securities, 25% to 35%. DIMENSION 6 - 27 Private placements are often referred to as story paper. The placement agent (investment banker) plays an important role in explaining the company’s strategy to investors. Recapitalizations or restructuring of the balance sheet, acquisitions, and significant capital expenditures are generally reasons why companies seek this form of financing. In addition, private placements may have one or more of the following benefits: Extended amortizations and maturities Fixed rate Covenant flexibility COLLATERAL CONSIDERATIONS Collateral will be required depending on the risk of the company’s business strategy and the structure of the transaction. The benefit of a private placement is that the structure, covenants, and amortization schedules can be tailored to the company’s needs and profile and the asset booked by the investor is not subject to regulatory guidelines typical of FDIC insured financial institutions or SEC (Securities and Exchange Commission) equity issues. SOURCES OF REPAYMENT If the issue is in the form of debt, the repayment structure should be closely linked to the cash flows of the company. In addition, repayment may come from the following sources: Liquidation of assets Refinancing KEY RISKS The bank is not extending credit; therefore, the key risks revolve around the bank’s ability to effectively serve as financial advisor and placement agent. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. PURPOSE DIMENSION 6 - 28 NOTES: LOAN SYNDICATIONS GENERAL FEATURES A syndicated loan is a credit facility that is originated by one or more lead banks acting as agents and sold to a group of financial institutions as participants. Loan syndications may be done on either a best-efforts or a fully underwritten basis. Syndicated loans spread the risk of large credit facilities across many institutions. The following structuring options are typical: Secured revolving lines of credit or term loans. Floating rates. 7–8 year terms. Varying amortization schedules. Facilities can be structured as: Revolving or term senior. Preferred stock. Private equity. Subordinated debt. A bank can participate in a syndicated loan either as a participant or an assignee. CRC US Body of Knowledge Participants purchase shares in the transaction, but do not have a contractual relationship with the borrower. Shares are purchased from the agent bank (who maintains the contractual relationship with the customer) after the closing; therefore, the participant is not party to the credit agreement. Assignees purchase shares in the transaction after the closing and do become party to the credit agreement. The assignment agreement creates a direct contractual relationship between the assignee and the borrower. Size of the transaction is generally $15 million or greater with terms of 364 days to 10 years. DIMENSION 6 - 29 Large financings requiring multiple banks generally occur in acquisitions, equity buyouts, recapitalizations or restructurings, and expansions or growth. A loan syndication is also employed where a corporation with multiple bank relationships wishes to coordinate its lenders with consistent pricing, documentation, covenants, and terms. COLLATERAL CONSIDERATIONS Collateral requirements will be dependent on the underlying risk of the borrower and structure of the transaction. SOURCES OF REPAYMENT The repayment structure of the debt should be closely linked to the cash flows of the company. KEY RISKS The key risks associated with loan syndications are: In a best-efforts situation, your institution, as the agent bank, will provide only their best estimate of the interest rate, terms and conditions, and the market’s appetite for the total amount of credit being syndicated. In a fully underwritten deal, your institution, as the agent bank, takes the risks of the entire principal amount of the debt offering and commits to the interest rate and the terms and conditions. Your institution will be required to hold the entire debt if you are unable sell off the debt offering. These risks can best be mitigated by: Understanding the market place for credit to your customer’s industry. Checking with other financial institutions to get a feel for their interest in the deal before committing to your customer. Acquiring credibility in the marketplace for such transactions by gaining experience in marketing syndicated deals. Ensuring that your institution has the investment capacity and appetite to take the entire security if you are unable to sell off any portion of the issue. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. LOAN PURPOSE DIMENSION 6 - 30 NOTES: HIGH-YIELD DEBT GENERAL FEATURES High-yield debt involves underwriting public debt issues for noninvestment grade companies. Standard & Poor’s ratings of less than BBB are considered non-investment grade and have greater default risk than investment grade companies. High yield debt is sold on a best-efforts basis. Ratings of AAA, AA, A, and BBB are considered investment grade and have minimal risk of default. The typical buyers of this debt are mutual funds, insurance companies, pension funds, and individual investors. High-yield debt transactions are generally subordinated debt transactions but can include any of the following securities: Senior secured or unsecured term loans. Subordinated debt. Convertible securities (generally debt exchangeable for equity). The key benefits of high-yield debt are: Fixed coupon rate. 7-to-12-year term or longer. Generally unsecured. Varying amortization schedules. Flexible covenants. CRC US Body of Knowledge Size of the transaction is generally $75 million or greater with terms of 7 to 12 years. Issues can be structured with call provisions (allows the issuer to repay the debt prior to maturity) after 3 to 6 years. PURPOSE High-yield debt is attractive to non-investment grade corporations involved in mergers and acquisitions, recapitalizations, refinancing, and project financings. DIMENSION 6 - 31 The bank is not holding the debt but serving as a placement agent for the company. High-yield debt is generally unsecured. SOURCE OF REPAYMENT The repayment structure of the debt should be closely linked to the cash flows of the company. KEY RISKS Key risks associated with high yield debt are: Your institution, as the agent bank, provides your best estimate of the appetite of the market for such debt and the interest rate and terms and conditions that would be involved with such an offering. Changes in the market or adverse events within your customer could cause the debt placement of the issue to be unsuccessful. These risks can best be mitigated by: Understanding the market place for debt securities placed by businesses in your customer’s industry. Checking with other financial institutions to get a feel for their interest in the deal before committing to your customer. Acquiring credibility in the marketplace for such transactions by gaining experience in marketing syndicated deals. Ensuring that your institution has the investment capacity and appetite to take the entire security if you are unable to sell off any portion of the issue. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. COLLATERAL CONSIDERATIONS DIMENSION 6 - 32 NOTES: COMMERCIAL PAPER GENERAL FEATURES Commercial paper is a financing vehicle for companies with investment grade credit ratings (AAA to BBB) that need low-cost, short-term, unsecured financing. Maturities of commercial paper range from 2 to 270 days. Corporations issue commercial paper directly to investors who may have temporary idle cash to invest. Such instruments are unsecured and generally discounted (sold at less than face value and repaid at face value at maturity), although some are interest bearing. They can be issued directly by corporations or through brokers, and they are generally available for financings in amounts of $50 million or greater. The maturity of the note, credit rating of the issuer, market conditions, and investor demand determine the rate, which can float, or be interest fixed for the term of the paper. PURPOSE Commercial paper provides short-term working capital funding with flexible maturities and lower rates (than bank funding) for investment grade corporations. COLLATERAL CONSIDERATIONS Commercial paper is an unsecured facility. SOURCES OF REPAYMENT CRC US Body of Knowledge Commercial paper issuers are top-rated companies. Bank lines of credit nearly always back commercial paper. This back-up line of credit covers maturing commercial paper notes in the event that new notes cannot be marketed to replace them and the company still requires financing. KEY RISKS Commercial paper has the credit risk of the underlying issuer or corporation issuing the obligations. Issues are supported by a public debt rating and public disclosure of financial information. Rating agencies like Moody’s and Standard & Poor’s assign ratings to commercial paper and generally require the issuer to have committed back-up lines of credit with a financial institution. DIMENSION 6 - 33 SPECIALIZED PRODUCTS NOTES: Letters of Credit Bankers Acceptance Asset Securitization In addition to defining the elements of each product, you will also Match structure with purpose. Identify sources of repayment. Determine the level of collateral required. Highlight and mitigate associated risks LETTERS OF CREDIT GENERAL FEATURES A letter of credit (L/C) is an instrument issued by a bank on behalf of its customer that gives someone (beneficiary) the right to draw funds upon the presentation of papers or documents in accordance with its stipulated terms and conditions. While this definition applies to all L/ Cs, a distinction is made between documentary or commercial L/Cs that are used to finance shipments of goods and standby L/Cs used for other purposes. Documentary L/Cs are typically used in international trade where the customer is not well known or the customer’s credit is suspect. Typically, the L/C is issued by the importer’s bank, called the issuing bank. The issuing bank’s L/C signifies that the bank agrees to pay the importer’s obligation to an exporter resulting from a sales agreement, contingent upon receiving appropriate documentation with respect to the shipment. In return for the L/C, the importer agrees to pay the bank the face amount and any fees. The L/C essentially substitutes the issuing bank’s credit for that of the importer. Standby L/Cs are issued in lieu of a guarantee and protect the beneficiary financially in the event the bank’s customer defaults. Standby L/Cs are used in commercial transactions, as enhancements in municipal bond transactions, and to guarantee performance on construction contracts. Banks provide this guaranty only for the obligations of their most creditworthy customers in which there is little likelihood of nonperformance. Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. The purpose of this section is to provide an overview and understanding of the application of each of the following products: DIMENSION 6 - 34 NOTES: For example, a construction company contracts with a school district (beneficiary) to renovate the local high school. The school district requires a letter of credit from the contractor’s bank that gives the district the right to ask for payment from the bank of an agreed-upon amount should the contractor fail to perform in accordance with a written construction contract. The contractor will be required to pay a fee to the bank, generally a percentage of the amount of the letter of credit, for this facility. DOCUMENTARY LETTER OF CREDIT (L/C) Step 1: Importer’s bank in Japan issues L/C to U.S. exporter’s bank in the U.S. Step 2: U.S. exporter ships goods to Japanese importer and presents shipping documents to U.S. bank. The U.S. bank credits the U.S exporter’s account for the face amount of the L/C and debits the Japanese bank’s account. CRC US Body of Knowledge Step 3: The U.S. bank sends the documents to the Japanese bank, which in turn debits the Japanese importer’s account for the amount of the sale and presents the shipping documents to the importer. Step 4: The Japanese importer claims the goods with the shipping documents. DIMENSION 6 - 35 Commercial or documentary L/Cs are commonly used in international trade. Standby L/Cs are used in business practice for firms to bid on projects or to purchase materials. With some awarded contracts, it may be a requirement that the company performing the work submit a performance guarantee via a standby L/C until the contract is satisfactorily completed. COLLATERAL CONSIDERATIONS Requiring collateral is dependent on the analysis of the customer’s ability to repay should the L/C be drawn. SOURCES OF REPAYMENT Your financial institution must be prepared to pay the beneficiary of the letter of credit, if the request for such payment conforms to the letter of credit’s terms and conditions. The letter of credit instrument serves as an indemnity covering the contract between the parties. With standby letters of credit, generally the parties satisfactorily fulfill their mutual obligations, without the need to draw under the standby letter of credit. KEY RISKS Key risks associated with letters of credit are: Your institution bears the payment risk on behalf of your customer. Your customer may be unable to perform under the contract associated with the letter of credit. Your customer may be unable to pay your financial institution if the letter of credit is presented for payment. These risks can best be mitigated by: Reserving borrowing capacity under your customer’s credit facility to cover the full amount of the letter of credit if it is presented for payment. Making a thorough assessment concerning your customer’s ability to perform and complete the work as detailed in the contract. See Documentary Letters of Credit for detailed information about the documentation requirements for this product. For further information, please refer to the Industry Resources section. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. PURPOSE DIMENSION 6 - 36 NOTES: BANKER’S ACCEPTANCE GENERAL FEATURES A banker’s acceptance is a time draft (signed, written order by which one party instructs another party to pay a specified sum to a third party on a certain date) drawn on and accepted by a bank. It is the customary means of effecting payment for merchandise sold in import-export transactions and a source of financing used in international trade. The draft allows a specified period of time after the goods are delivered and the draft is presented before payment is due. When the importer’s bank accepts the draft, the bank guarantees that it will pay the draft on maturity. Essentially, the bank replaces the importer’s credit with its own credit. The exporter may attempt to sell the banker’s acceptance to an investor at a discount that is consistent with the market rate. Alternatively, the bank may extend credit by buying the acceptance from the exporter at a discount. The bank sells it in the banker’s acceptance market and at maturity pays off the investor at face value as the payment from the importer comes due. PURPOSE Banker’s acceptances are primarily used to finance international trade. COLLATERAL CONSIDERATIONS Collateral is generally unnecessary due to the underlying creditworthiness of the bank that supports these facilities. SOURCE OF REPAYMENT CRC US Body of Knowledge The draft is paid under the terms of the instrument, usually 30 to 180 days, and is structured to match the flow of goods and services that are being financed by the underlying transaction. KEY RISKS The credit risk of a banker’s acceptance is minimized since it has the unconditional guarantee of the accepting bank. Secondarily, it is a liability of the importer of the transaction for the full-face amount. They are traded in a highly active secondary market. DIMENSION 6 - 37 GENERAL FEATURES Asset securitization involves pooling homogeneous groups of assets, such as credit card receivables, mortgages, corporate accounts receivable, auto, or consumer loans and financing them with securities (credit instrument that signifies ownership) that are sold to investors. These securitized notes or bonds are serviced by the cash flow of the underlying pool of assets. In structuring an asset-backed security, the assets are generally sold to a specially created trust or special-purpose corporation that issues the securities that are collateralized by the assets. Credit enhancements in the form of guarantees, over-collateralization, or a reserve account are generally required. This credit enhancement provides the opportunity for higher ratings by rating agencies. A financial institution may assume one or more of the following functions in an asset securitization transaction: Set up or facilitate the set-up of a trust or special-purpose corporation to purchase assets and issue securities. Act as a servicing agent to structure the transaction, analyze the assets, perform due diligence and credit reviews, and monitor the credit quality of the portfolio. Collect interest and principal payments on the assets and transmit those funds to investors. Be the supplier of the assets that are securitized. Provide some form of credit support or credit enhancement. Provide liquidity support to the trust. NOTES: Dimension 6 // Identify Repayment Sources and Appropriately Structure and Document Credit Exposures for.. ASSET SECURITIZATION