Inadvertent errors in calculating debt service coverage can be costly. It is
critical to accurately determine a borrower’s ability to repay, especially with
today’s unstable economy. Discover how to avoid mistakes while learning
more about making accurate determinations and prudent decisions.
- Identify potential vulnerabilities which could lead to inaccurate assessment of
borrower repayment ability (debt service coverage)
- Discuss common errors in the calculation of global debt service coverage which could
lead to overstated secondary repayment ability
- Distinguish between different repayment ability calculations and when each is most
appropriate, including traditional EBITDA coverage, free cash flow, and uniform
- Recommend the level of financial statement assurances which will lead to the most
confident lending decision, given loan amount, transaction, and borrower complexity
- Understand common weaknesses in the institution’s development of repayment
ability as found through third-party, independent loan reviews
The traditional five Cs of credit serve as the foundation for the assessment of credit risk
inherent in loan origination and ongoing monitoring of the institution’s loan portfolio. Of
the five Cs, capacity is often the most important factor in credit risk assessment. The
emphasis in underwriting member business loans shifts from the individual to the financial
soundness of both the business and the member requesting the loan (Loan Types –
Appendix 10A NCUA Examiner’s Guide). Therefore, to ascertain “financial soundness,”
the institution must determine repayment capacity of both the business and the member.
For this reason, accurately determining a borrower’s ability to repay is critical, especially
in times of economic instability. This presentation will focus on the factors which could
lead to inadvertent errors in the calculation of debt coverage, which could prove to be costly in the credit relationship if the institution incurs loss. Losses and potential erosion
of capital are of greatest concern; however, institutions must consider the negative impact
erroneous credit decisions (caused by underwriting errors) may have on the borrowing
entity and its ownership. Prudent decisions based on accurate determinations protect the
institution and the interests of borrowers and related entities.
Aaron Lewis, Young & Associates, Inc.
Aaron Lewis is a senior consultant at Young & Associates, Inc. With over 15 years in the
banking industry, his expertise is now dedicated to the lending division of Young &
Associates where he assists financial institutions with loan, ALLL, policy, and credit process and compliance reviews. He also conducts seminars on credit risk and compliance.
Prior to joining Young & Associates, Aaron was the Vice President Credit Administrator of
a community financial institution in southeast Michigan and managed all facets of the
lending function, including originations, underwriting, ALLL analysis, servicing, and
secondary market compliance. He holds a Bachelor’s in finance from Michigan State
University and graduated from the Graduate School of Banking, University of Wisconsin.