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It is mandatory to procure user consent prior to running these cookies on your website. The department will schedule its work so that each individual credit exposure including every loan and facility will be reviewed at least once a year and more often if needed. Special attention will be given to credits, which are past due. A well-designed risk rating system will, in effect, assign a broad probability of successful repayment to each extension of credit and also provide information to management with respect to those loans whose quality is impaired and must be provisioned or written off.
Generally, higher risks are compensated by higher rates. Avoid concentrations in loans from the same local, national or cross-border geographic region or economic area. This means that not all loans are concentrated in the same maturity band or expire during the same period.
The result of good diversification is a reduction of risk on an overall portfolio basis. This means that a Banking unit with good diversification can generally take on somewhat riskier assets than a Bank with a concentrated portfolio. A good management information system will assist a Bank in managing its portfolio by presenting organized and timely information with which to measure inherent risks.
Management will be able, therefore, to issue instructions or write policy guidelines that focus on the kind of loans it desires in its portfolio over time. Some are major and result from some of the factors mentioned above which have become aggravated, and which may have a significant impact on risk. The Iraqi economy has experienced difficulties in general in past years given the impact of sanctions and the wars. While some companies have had difficulties in expected business activities, others have continued to operate profitably and according to their plans.
In considering the specific request of borrowers for a restructuring, the Bank should look at each request on a case-by-case basis. Restructures of principal repayments or other modifications that materially change the payment terms of the original Loan Agreement should be examined carefully. Consideration should also be given to requiring increased financial reporting to the Bank. It should be cautioned, however, that for a borrower in very serious difficulty, this might only serve to compound the problem and hasten a failure.
There may be other bank-specific policies that should also be followed in dealing with restructure modifications. In any event the approval process for restructuring a loan should follow the process guidelines mentioned above. Normally any loans or facilities past-due for more than a specified number of days, frequently ninety, will automatically be transferred to the Settlement Department. In cases where there is an imminent risk of loss, the loan should be transferred without regard to the number of days it may be past-due, and even if it is still current.
At that same ninety-day point or other time limit set by Bank policy , all interest accrual should cease and any interest already accrued and taken into income should be reversed. The Settlement Department will be responsible for the following: Examine and evaluate the problem credit situation including an assessment of the risk, a review of the adequacy and completeness of credit documentation, and, if applicable, collateral perfection, as well as an analysis of the condition, marketability and current market value of the collateral.
Formulate a future strategy or an action plan to be followed in dealing with and resolving the problem credit. Retain outside counsel to provide specialized legal assistance when required. Implement a strategy in order to restore the credit to a fully performing status or get the outstanding balance fully repaid, restructured, or adequately secured to mitigate against loss. Estimate the probability of full recovery and the likely costs in terms of actual expenses, employee time and foregone income associated with succeeding.
If there is a low probability of full recovery coupled with high costs over an extended period of time, the Bank, through action of its Credit Committee, might make a business decision to attempt to settle the debt immediately for less than the full amount owed, taking a smaller and certain loss now as opposed to a possibly larger and uncertain loss later.
Prompt and effective resolution of problem loans can reduce losses for the bank. Problem loans are costly to the bank in terms of time and effort as well as, frequently, foregone interest income and additional expenses.
Ultimately problem loans reduce profits and can erode capital. The files also serve as the historic record of client relationships. Credit files are the basis for approvals, for independent internal credit or audit reviews, as well as external reviews by examiners who test for credit quality, compliance with Central Bank of Iraq regulations and Bank policies, guidelines, procedures, and internal controls.
Contents The contents of a credit file will vary depending on the transaction, amount and type of financing involved. However, the credit file should enable a reviewer to make an independent judgment of the credit and the rationale or credit logic underlying the credit decision.
Active credit files should contain current pertinent information and cross- reference other relevant information in other files. It should contain all relevant documents including a copy of Application Form, the Loan or Facility Agreement and Transaction Recommendation. It should also contain all documentation relevant to Guarantees and Real Estate Collateral, registered moveable assets, cars, etc. It will also containing all supporting documentation listed in Appendix A.
The credit file must be prepared by Branch Credit Administration within 24 hours, or as soon as feasible, after the loan application has been received and will accompany the recommendation to the highest Credit or Advisory Committee for approval. Loan information: Principal outstanding Past due interest 2. Key ratios and margins Current ratio Leverage ratio Gross profit margin Operating margin Debt service coverage ratio 4. Assessment of subjective factors Describe any changes in collateral condition.
Describe changes in Management and key personnel. Describe any important changes in the company. All ratings shall be reviewed at least on a quarterly basis. It is important that all staff recognize that assigning risk ratings is a subjective endeavor, which will be successful only to the extent that each individual exercises good judgment based on experience and common sense coupled with good analytic techniques.
Standard Risk An asset classified as Standard is supported by sound net worth and paying capability of the borrower. Watch-List An asset classified as Watch-List is adequately protected but is potentially weak. Such an asset constitutes an unwarranted credit risk but not to the point of requiring a classification of Substandard. The credit risk may be minor, and in most instances, bank management can correct the noted deficiencies. Yet such risk is considered undue and unwarranted in light of the particular circumstances surrounding the asset.
In no circumstance should a Watch-List category be utilized as a compromise between the classification categories of Standard and Substandard. Substandard An asset classified as Substandard is inadequately protected by current sound net worth and paying capacity or by the collateral, if any, supporting it. Such an asset has a well- defined weakness that jeopardizes the liquidation of the debt.
It is characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Assets that are past-due days for principal or interest payments must be classified as substandard at a minimum. Doubtful An asset classified as Doubtful has all the weaknesses inherent in one classified as Substandard with the added characteristic that these weaknesses make collection or liquidation in full, on the basis of current circumstances and values, highly questionable and improbable.
Although the possibility of loss is thus extremely high, because of significant pending factors, reasonably specific, which could be expected to work to the advantage and strengthening of the asset, its classification as a estimated loss is deferred until its more exact status may be determined.
Examples of such pending factors include but are not limited to mergers, acquisitions, capital restructuring and the furnishing of new collateral or realistic refinancing plans. Assets that are past-due days for principal or interest payments must be classified as doubtful at a minimum. Loss An asset classified as a Loss is considered not collectible and of such little value that its continuance as a bankable asset is not warranted.
A Loss classification does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future. An asset that is past due over days for principal or interest payments must be classified as Loss. Financial analysis for facilities or loans to be used for this purpose should focus on past performance of inventories and receivables in terms of turnover and asset quality together with reliable client information related to anticipated levels of sales.
It is important to monitor inventory purchases, sales levels during the period and the collection of receivables. Ample information about key buyers and suppliers is important to have. Seasonally related finance is an equally good way to describe this kind of product.
All short term working capital loans should be repaid in full periodically, preferably once a year for at least 30 days. This should be the case whether the finance is provided by means of a facility or a loan. Working Capital Loans up to 36 months Working capital loans can be made for more than 12 months. The difference between short and long is related to the theory of working capital - when finance is provided on a long-term basis, working capital in a measurable, accounting sense actually can increase until loan proceeds are used.
It may be called "permanent working capital" but the underlying finance has to be repaid, in this case out of positive cash flows, essentially profits plus depreciation and positive flows from working accounts, not conversion of assets.
When are longer-term working capital loans made? There are no hard and fast rules except that such loans are not repaid from specific asset conversion as noted. USAID Iraq Economic Governance II Credit Policy Manual April 16, sales it may take some time to reach appropriate levels , higher profits and profit margins, and depreciation are the funds sources that repay long-term working capital loans.
Deciding when long-term working capital loans are appropriate is a matter of good financial judgment combined with good financial analyses of cash flows and understanding of the project. They are made for many purposes, among others, to supplement working capital and most commonly to finance the purchase of modern machinery and equipment. Depending on the purpose of the financing and cash flows, term loans could have a final maturity of up to eight years, although three to five years is more common.
The repayment of term loans, therefore, is not expected to be the result of asset conversion as is the case of seasonal financing to support inventory and receivables buildup; funds for repayment are expected to be generated by the asset s financed and repayment should conform to the anticipated levels and timing of cash flows. Acquisition of Plant and Equipment - loans for fixed asset expansion are the most common and easiest from a risk analysis standpoint to justify.
Working Capital — term loans for working capital purposes are perfectly in order when a company has grown so fast that internal capital formation has not kept pace at normal levels, or fixed asset expansion requires additional support to be viable. These loans are more difficult, however, to analyze from a risk standpoint.
The banker as well as the borrower will have to anticipate higher earnings that are sufficient to retire the debt on a timely basis and cash flow analysis has to support this expectation.
Project Financing - Term loans to finance new ventures or projects are the most difficult to analyze and approve. Frequently, the economic feasibility of projects is unknown and must be subject to market studies and technical appraisals including the prior identification of supplier and buyer commitments. However, good historical performance and operating practices are vital to creditworthiness.
The risks involved in project financing, in addition to mortgage collateral, must often be offset by third party undertakings written commitments from suppliers and buyers , completion guarantees, shareholder undertakings and of course these risk mitigations must be properly documented.
The raw material for a thorough financial analysis should include at least three prior years of financial statements if possible, preferably certified by an independent accountant.
In addition, pro forma balance sheets, income statements and cash flow calculations for the anticipated life of the term loan projections , are prepared by the borrower. The lender should not have to prepare these projections; there are many uncertainties in making pro- forma statements.
They are based largely on historical business performance together with anticipated results from the term financing and many assumptions have to be made concerning both balance sheet and income statement items. The projected balance sheets and income statements for each year should also include annual cash flow statements. These will take the total income and depreciation for each year, add or subtract the net changes in operating accounts essentially receivables, inventories and payables to derive total cash from operations for the projected year.
The resulting number is a rough approximation of the cash from operations that is available for debt service for each year, i. Obviously, cash from operations should exceed debt service requirements by a healthy margin. Documentation of Term Loans Every loan transaction involves risk. However the risks involved in a day loan are generally predictable, while the risks involved in a five-year loan cannot be easily assessed.
A good term agreement will describe the loan, its repayment terms, the purpose of the financing, and describe the collateral. It will require that loan funds be used for the purposes of the loan. It may contain completion dates. Frequently financial ratios, such as a current ratio or debt to worth ratio are required so that the banker can monitor the financial condition of the borrower.
It may require that dividends not be paid before the bank is paid to preserve working capital and there may be limitations on total indebtedness with or without the consent of the lending bank. Changes in corporate structure or corporate name may be prohibited along with sale of key assets without lender consent.
It may limit investment in other companies, prepayment of other long-term debt, or impose limitations on executive salaries. The latter are a function of the possible risks involved during the life of the loan.
Monitoring of Term Loans The term loan agreement itself provides the key basis for monitoring. A borrower is expected to notify the lender when there is a default or in anticipation of a possible default. A properly drafted Agreement, properly monitored, applicable to a term financing project that on the basis of good risk analysis will guide both borrower and lender to help ensure project success as well as repayment. These are generally loans for shorter term needs three years maximum.
Land acquisition loans for agricultural or other commercial purposes, secured by real estate, are discussed in other appendices. An example would be if a manufacturer has the opportunity to purchase a tract of land, which would be required for the future expansion of his plant. The problem for the Bank is that there is no identifiable source of cash flow from the real estate acquisition to repay the loan.
In this case the Bank must identify and depend upon alternative sources of cash to repay the loan. In this situation, the Bank must reasonably determine that funds will be available at some defined future date to repay the loan. Unless this can be determined the loan should not be approved.
Sources would primarily be financing from another source either within the Bank or externally. If the source is external, the Bank should obtain a binding commitment. Sources could include but are not limited to other financial institutions, Iraqi Government Agencies, or international organizations. The Bank should make every effort to ensure that the commitment from the outside source to repay the loan is binding.
If there are conditions associated with the commitment, the Bank should require that these conditions are met before the Bank approves the loan, or in limited cases ensure that the borrower has the ability to fulfill all conditions in a timely manner. This would be the case where the borrower will, at a specific future date, present the bank with another proposal to finance the construction of a facility, or other improvement on the property, which would create utility cash flow to the borrower.
Also the Bank must determine any impediment legal, physical, or other , which would preclude the use of the property for its intended purpose. Construction Loans These are loans to be used to construct facilities and buildings on property.
Construction loans should only be granted to borrowers who demonstrate the expertise and capability to complete the proposed construction within the stated period at the planned cost.
Delays and cost overruns will very negatively impact the ability to complete the project. Funding of the loans should be staged in portions over the life of the loan. The Bank needs to analyze the construction project and determine acceptable stages of completion of the project to establish identifiable points of completion when agreed upon amounts of the loan will be funded to continue the construction through the next stage.
The Bank will analyze these materials, or may require the review of an expert of its choice to determine that the materials and costs presented are reasonable to complete the project.
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