Adv FSA Homework Qingli DuQingli Du SunTrust Case 1, Calculate the ratio of the allowance for loan losses to nonperforming loans and the ratio of the allowance for loan losses to net loan charge-offs for each major type of loan for SunTrust in 1998, Explain the differences in the two ratios for each type of loan and in a given ratio across types of loans. Do you believe these differences are primarily attributable to economic differences across types of loan, to SunTrust’s provisioning for loan losses, or to ‘SunTrust’s loan charge-off poli [Allowance for loan losses, 2514 2298 4209) INonnerforming loans 501 144 125] [Ratio 502%. 160% _ 33679 Charge. of fs 49 222 193.1) Recoveries, 148 114 446) INet loan charge- of 342 108 1485) IRatio P35%, 2128% 283Y The differences mainly attribute to SunTrust’s loan charge-off policy. Not all nonperforming loans would be charge-off. Some allowance is for really bad loans, and some other loans is for loans in much better portfolio that has little probability of going bad or for previously restructured loans, In addition, traditionally a bank will make this declaration at the point of six months without payment. But nonperforming loan (NPL) is the sum of borrowed money upon which the debtor has not made his or her scheduled payments for at least 90 days, Some debtor will pay back loans or interests between 90 days and 180 days after due day. Thus, charge-off amount is naturally smaller than nonperforming loan amount. 1/6 “hissy source was downloaded by 100000844729249 fom Coureler com on 12-18.2622 01:32342 GMT 1600 pest couche. com/i/ 818009514 FSA-HHomeworkQingli Du 2, Calculate the ratio of recoveries of prior charge-offs to gross charge-offs by type of loan, For what type of loan are recoveries highest? Why? Do recoveries indicate anything about discretion over loan charge-offs? Ratio ‘Commercial loan has the highest recovery rate up to 78%, which indicates that there has over charge-offs in commercial loans. If SunTrust has made good assessment in its bad debt, the recovery rate should not have been so high. The company announces debt died in such quick speed on purpose. High recovery rate often indicate over charge-offs. SunTrust intended to increase the charge-offs in order to increase the allowances in current year. And in the following bad years, the company could add back these over reserved expenses and made its earnings looks better in bad years. It over charged-off its bad debt to bank future earnings. 3, Which is the better benchmark for the allowance for loan losses for SunTrust 2/6 “Thi std source was downloaded by 100000844729249 fom Coureler com on 12-18.2622 01:32:42 GMT 0600 pest couche. comfie 818009514 -FSA-HHomework!Qingli Du for each type of loan: nonperforming loans or net loan charge-offs? Why? For consumer loans, net loan charge-offs is the better benchmark. For commercial loans, nonperforming loans is the better benchmark. Since allowances for commercial loans include three year non-performing loans. For Real Estate loans, nonperforming loans is the better benchmark. 4, Calculate the ratio of the provision for loan losses to net loan charge-offs for ‘SunTrust from 1993 to 1998, Do its provisions for loan losses seem excessive? 1983 1994 1951919971988 lprovison for loan losses 2524 1494 aaa 2051 214, Inet loan charge- off 1849 10211295199 1908 193, atin, 137%. AFP 117% ane 118%. D For the most of years except 1996, the provisions for loan losses seem excessive Provision is mainly used to set against charge-offs. Since only in the year of 1996, Provision/Charge-offs ratio is lower than 100%, indicating that provision for loan losses exceeds charge-offs. Sometimes, companies over reserve allowances for bad debt. In good years, a bank tends to allocate higher allowances than necessary, whereas a bank tends to attribute lower allowances in bad years. Since in bad years the bank will have less earnings than in good years, and less allowance can make earnings higher. On the other hand, in good years, more allowance can help reduce earnings a litle more, resulting in a smoothing earnings over the years. Also in good years, the bank has enough ability to absorb bad debt, thus more allowance is attributed during bad years 5, Is SunTrust appropriately reserved for loan losses at the end of 1998? At the end of 1998, the Provision/Charge-off ratio is 111%, indicating that provision exceed net charge-offs and SunTrust over-reserved for loan losses. Maybe year 1998 3/6 “Thi std source was downloaded by 100000844729249 fom Coureler com on 12-18.2622 01:32:42 GMT 0600 pest couche. com/i/ 818009514 FSA-HHomeworkQingli Du is a good year for SunTrust, and so it reserve excess allowance for loan losses and bank the earnings for future bad debts. WAMU Instructions , deterioration) in credit metrics over time. For 1, Analyze the change ( example, how have non-performing loans as a% of total loans trended over time? 200320042005. 2006-2007 INonperforming Loans 1626 15¢@__1686 2295 6.123) lLoans in portfolio 175.150.207.071 229.632 _ 224.960 _ 244.386] IRatio 09% 0.74% 07H 1.02% 25194 NPL/Loans NPLiLoans declined at first from 2003 to 2005. In 2005, it reached bottom and increased rapidly in the following years from 0.73% to the amazing 2.51% in 2007. WAMU has relatively safe credit policy in the early years, but in 2007 the company was in much more dangerous credit situation with nonperforming loans increases much more sharply than total loan amounts. 2, Does the allowance for loan losses appear adequate? First, compare the allowance to non-performing loans. Second, try to determine the amount of super-risky loans, such as HELOCs (home-equity lines of credit), second liens, Options ARMs (i.e., negative amortizing loans and interest-only loans). Then, guestimate what those risky assets might lose over time. Third, is there any evidence that WAMU was required to buy back loans it securitized and sold? If so, has that amount increased over time? What, if anything, does it say about credit quality? Fourth, do the fair values of some of the assets suggest some real problems in the loan portfolio? Fifth, how was the credit card loan portfolio doing? Was that as problematic as the mortgage assets? 4/6 “Thi std source was downloaded by 100000844729249 fom Coureler com on 12-18.2622 01:32:42 GMT 0600 pest couche. com/i/ 818009514 FSA-HHomeworkQingli Du 200320047 200520062007 lAllowances For Loan Losses 12501301 1695 __1.630__2571| INonperforming Loans 1626 154 1686 2295 6123 lALWNPL 76 88% BABI 10053% 71.02% __41.90°4 It seems like that allowance for loan losses is not adequate in the end of 2007. During 2003 to 2007, allowances level first increase than decrease to 41.99%, leaving a more than half of nonperforming loan unreserved for losses. 200320042005 2006-2007 |Home enuity loans and lines of credit 27.644 43648 _S0.840__52882 60.96: fotal loans held in portfolio. 175150 207071 229632 224.960 244386 ‘Home loans is increasing gradually. There is big difference between the fair value and book value of home asset in WAMU. WAMU has large portion of loans attributing to home equity loans, and the fair market value of home behind these loan faces high risks of decrease. 200320042005 2006-2007 (Crest card 0 0804310861 __g831| fotal loans held in portfolio. 175150207071 229632, 224.960 244,386, lRatia 0.00% 0.00% 350% 483% 3.619 Credit card loans also has similar risk faced by home loans. 3, What is/was the bank’s core earnings power, before the provision for bad loans? As of the end of 2007, was it reasonable to expect WAMU’s core earnings power to generate enough earnings to offset credit losses? A bank’s core earning power is the ability to generate interests and principals from Toan lent out. But at the end of 2007, WAMU’s nonperforming loan increased almost triple. Thus WAMU experience significant risk of losing’ earnings from those nonperforming loans. In tum it cannot generate enough earnings to offset credit losses. 4, If housing values declined 30%, what would that do to the credit statues provided by WAMU? The fair value of housing represents the market’s ability to buy these assets. The ‘market pricing can fluctuate over time. AMU has lots of Real Estate loans secured by housing. If housing value declined 30%, credit statues provided by WAMU has to be lowered. 5/6 “hissy source was downloaded by 100000844729249 fom Coureler com on 12-18.2622 01:32:42 GMT 0600 pest couche. com/i/ 818009514 FSA-HHomework