Question: When do you need to obtain a Flood Certificate?

Answer: A flood certificate is obtained before a loan is made, increased, extended, or renewed. A previous flood certificate can be used if it is less than seven (7) years old and the area has not been remapped.

Question: When is Flood Insurance Required? How much Flood Insurance is required?

Flood insurance is required when the improvement securing a loan is located in a designated flood zone as determined by FEMA (Federal Emergency Management Agency) and flood insurance is available.

Flood insurance is intended to cover the improvement. The minimum amount required is the lower of the loan amount or value of the property less the value of the underlying land.

A brief history on the program and requirements for your entertainment….Congress established the National Flood Insurance Program (NFIP) to make flood insurance available to areas that are identified as at high risk for flood disaster and involves both the government and private insurance industry. The Flood Disaster Protection Act (1973) made it lenders responsibility to determine which properties are most vulnerable to flood and enforce the purchase and maintenance of flood insurance. The regulation applies to all federally regulated banks and lending institutions. Determination is documented on the Standard Flood Hazard Determination Form (Flood Certification is how those of us in the industry typically identify this document). Determination is applied to improved property and not non-structural improvements such as a parking lot or separate septic tank and includes construction loans to put improvements on land. The Federal Emergency Management Agency (FEMA) designates flood zones (A or V). If insurance is available, then insurance is required. The bank must obtain evidence prior to the close of the loan and ensure that insurance remains in place for the life of the loan. It should be noted that communities have the option to opt out of this national program. If flood insurance is not available, then the bank at its discretion can require that the borrower purchase private flood insurance. The described situation would be a case where the bank would need to make a judgment call about the best business practice.

Source: FEMA.gov

]]>Add any insight you have related to Loan Policy in the comments and share this post with your friends and colleagues. Your contribution is greatly appreciated.

]]>**DSCR Calculation**

The formula for the Debt Service Coverage Ratio (DSCR) or Debt Service Ratio (DSR) is as follows.

=Cash Available to Service Debt ÷Total Loan Payment

Cash Available to Service Debt is NOI with adjustments.

=Net Operating Income+ (Depreciation & Amortization) +Interest Payments+/-Distributions (Contributions) +/-Change in Loans to Owners

If you calculate cash available to service debt using a financial statement for one year (12 months), then total loan payment will equal a total of twelve months of monthly payments. If you are using an interim statement for nine months, then your total loan payment will equal a total of nine months payments and so on.

Using our example from the first post, we calculated the monthly principal and interest payment at $10,187.21. We calculate Cash Available to Service Debt at $350,000 for the borrower as of the previous year-end (using 12 months). To calculate DSCR we divide $350,000 by $122,246.52 ($10,187.21 * 12).

DSCR=$350,000 ÷$122,246.52 =2.86 and expressed as 2.86 times coverage.

Is this DSCR good or bad? It is good by most standards and indicates that the borrower’s capacity to repay the loan for the period was 2.86 times what was needed to cover the debt payment. Check your bank’s lending policy. There will be policy on minimum requirements. A DSCR of 1.00 means that borrower has just enough cash available to cover the debt payment and anything below 1.00 means that borrower does not have the capacity to repay the debt under the loan terms.

**Loan to Value (LTV) or Loan to Cost (LTC)**

LTV is a measure of collateral coverage based on the appraised value of collateral while LTC or loan to cost measures collateral coverage based on the cost of the collateral. Loan policy dictates a maximum advance rate or coverage to be used in your analysis and underwriting.

LTV= Loan Amount ÷ Appraised Value, and is expressed in %.

LTC= Loan Amount ÷ Total Invoice, and is expressed in %.

The main takeaway from the basic calculation series is that you should know how to make these basic calculations in your analysis. In time you will run into situations where the calculation requirement may be more problematic. If you can not find a solution on this site, email me at Help Me With DSCR or LTV Calculation. Thank you and remember to share this with your friends and colleagues.

]]>You will want to know how to calculate periodic payments (monthly, quarterly, annual) using a financial calculator, Excel worksheet or pen and paper.

**By Hand (with the assistance of a calculator)**

We start with this method because the formula introduced here is the same one used in the Excel Method and the basis for the calculation made by the calculator. The calculation is best demonstrated using an example.

Borrower is requesting a $1,700,000 loan for the purpose of acquiring 20% share in a medical office building. The bank agrees to make the loan with a 75% advance rate and will price the loan at 5.25% amortized over a 25-year period. Borrower will be required to make monthly principal and interest payments. The loan matures in 5 years. What is the monthly payment?

The formula is:

Where (PMT) is the payment, (PV) is the loan amount, (i) is the periodic interest rate (rate divided by the number of payments each year), and (n) is the number of payments in total (number of payments each year multiplied by the number of years the loan is amortized).

The monthly periodic principal and interest payment is $10, 187.27

What if the payment was interest only monthly?

The monthly interest payment is $7,437.50

I used my HP12c and heavily use the memory function to save calculated values instead of rounding. This reduces rounding error.

**Excel Worksheet**

You can set up your worksheet the way I have it below.

I show the worksheet with the formulas visible below for your reference.

Notice that the payment is the same as calculated in the By Hand Method. This is because the formula used is exactly the same.

**Financial Calculator**

Remember to clear your calculators register before beginning. Enter the values into the calculator as shown below and hit the PMT button to calculate the payment.

n=300

i=.4375

FV=0

Hit PMT Button

The monthly principal and interest payment calculated is -$10,187.21.

The negative represents a cash outflow. Borrower pays cash out of pocket to the bank for cash into his pocket in the amount of the loan. If you wanted the payment to show up as positive $10,187.21, then you enter the loan amount as a negative number.

In summary all three methods yield the same answer. There may be some difference due to rounding. Pick the method that works best for you and stick with it.

If you have additional questions regarding this topic, post your question below or email me at Help Me With Payment Calculation. Thank you and remember to share this with your friends and colleagues.

]]>The bank makes a loan to a borrower and creates an earning asset on its balance sheet. The bank has a motive to structure the loan to maximize its profit or return on the asset and minimize its risk of a loan default or non-repayment. Interest rate charged and fees become the vehicle for the profit or return. Maximizing advance rates on collateral (maximizing the LTV or LTC) at origination, shorter amortization periods and maturities, financial reporting and performance requirements such as maximizing total debt held by a borrower or minimum liquidity are vehicles for minimizing risk. These requirements may be the basis for approving a loan and/or covenant requirements for which non-compliance would result in an event of default with stiff penalties on the borrower.

On the other hand, the borrower is motivated to minimize the cost (the interest rate and fees paid) and out-of-pocket expense of taking the loan. Minimizing interest rate and fees paid, longer amortization periods and maturities which reduce the payment as well as lower advance rates on collateral allows for the borrower to achieve this. On advance rates-lower advance rates allows the borrower to keep more money in the bank while higher advance rates may require the borrower to inject additional capital into the project or investment.

Negotiations of loan terms become extremely important in the process of making a loan.

In your analysis you are making a determination of the borrower’s ability to repay the loan under the terms negotiated.

]]>The borrower will be the best source of information related to internal factors affecting cash flows such as marketing, sales, business operations, management, etc. The borrower can also identify its direct competitors for the analyst and provide some direction on good sources for market information. The main takeaway from the conversation is the identification of the principals and details on their background, experience and involvement with the day to day activities, planning and management of the business as well as an initial indication of the financial position of the borrower. The analyst should be able to determine the level of collateral dependence for the loan request and have some idea about the market environment for which the borrower operates and understand other influences such as the economy, political environment, industry and competition that would affect the borrower’s ability to repay the loan.

The analyst collects financial information from the borrower to perform financial analysis using various financial modeling techniques such as spreading the financial statements in Excel, Moody’s Risk Analyst, Financial Tools, or Buker’s Taxanalysis to determine the financial position of the borrower from a historical and forward looking perspective as appropriate. The feasibility of the loan is determined mainly by cash flow as a lender would not make a loan to a borrower with cash flow that is insufficient to repay the loan. Other important factors that are identified in the analysis are borrower liquidity, leverage, and sustainability. Market data should provide an indication of how strong the borrower’s performance has been relative to the market. Strong performance indicates good management and business sustainability and lower probability of default on the subject loan. I am preparing a series on spreading financial statements that will cover the modeling techniques I use in my analysis.

One final note is that the level of detail in the analysis should be guided somewhat by the lender’s attitude towards risk and appetite for specific types of loans, borrowers, and financial strength. Lower risk tolerance environments will require a higher level of details. At any rate the analysis should be comprehensive. Calculation methods should be easy to follow and duplicate and it is good practice to reference sources and methods. Management may not find errors or inconsistencies in the analysis. Check your work. You do not want your auditors or examiners catching errors that you should have.

Tools-The document under tools labeled Checklist is a checklist of financial information to collect from the borrower to start your analysis. An important item on the list to note is the Debt and Maturity Schedule. This will enable the analyst to determine if there are going to be any upcoming liquidity events that could adversely affect cash. If you look under the Tools section there is a link to an Excel file titled Debt and Maturity Schedule that you can use.

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