This document provides an introduction to quantification tools for loan restructuring. It discusses topics such as the CAMPARI framework for credit analysis, the 5 Cs and 5 variables used to analyze loans, and how compounding interest, risk, and term extensions impact the total cost of credit. Quantitative examples are provided to illustrate concepts like how increasing the loan term reduces monthly payments but increases the total interest paid over the life of the loan.

1. The Quantification of
Loan Restructuring
An Introduction

2. Goal
Create Awareness of some Quantification Tools
Effect of Compounding
Risk
Impact of Term Extension
Why Fixed Rates Create Break Costs

3. Topics
Qualitative
CAMPARI
5 Cs
Quantitative
The 5 Variables
Compounding
Drivers of Interest
Risk
Term Extension

4. Loan Book Management
Management of the Loan book
Portfolio
Correlations
Portfolio Risk
Economic Capital
Facility specific
Default & Migration (deterioration)
Exposure at Default & Loss Given Default

6. Campari
Character
Know your customer
Ability
To repay
Margin
Pricing: cost of funds,
risk, profit
Purpose
Use of loan proceeds
Amount
Size of loan
Repayment
income, savings,
asset disposal
Insurance
Credit enhancement
Security
Guarantee

7. Legal
(Subject to Cost
Benefit Analysis)
Loss
Sympathetic
Work-out
Loss
Legal
?
New Arrangement
Forbearance
No Loss
Attitude
Ability
Don’t Want to Pay
Can’t
Pay
Want to Pay
Can
Pay
Current Arrangement
No Loss
Character & Capacity

8. 5 Cs
Character
Know your customer
Capacity
Ability and sources of repayment
Capital
How much is the borrower investing in the project?
Conditions
What are the loan covenants?
Collateral
Security & Credit Enhancement

9. Quantification
What are the key factors?

10. 5 Variables…
The Variables:
Number of Periods (N)
Interest rate (i)
Present Value (PV)
Payment per Period (PMT)
Future Value (FV)

11. [Financial Calculator]

12. 5 Variables…
The Variables:
Number of Periods (N) 1
Interest rate (i) 10%
Present Value (PV) €100
Payment per Period (PMT) €110
Future Value (FV) €0

13. Loan of €100 – 1 year
(10%)
(€100)
(€50)
€0
€50
€100
0 1
C
a
s
h
F
l
o
w
Years
€110 in the year

14. Total Cost of Credit
1 Year
Repayment €110.0
0
No. of Years x 1
Total €110.0
0
Loan Value €100.0
0
Cost of Credit €10.00

15. 5 Variables…
The Variables:
Number of Periods (N) 2
Interest rate (i) 10%
Present Value (PV) €100
Payment per Period (PMT) €57.62
Future Value (FV) €0

16. Loan of €100 – 2 years
(10%)
(€100)
(€80)
(€60)
(€40)
(€20)
€0
€20
€40
€60
0 1 2
C
a
s
h
F
l
o
w
Years
€57.62 per year

17. Total Cost of Credit
1 Year 2 Years
Repayment €110.0
0
€57.52
No. of Years x 1 x 2
Total €110.0
0
€115.0
4
Loan Value €100.0
0
€100.0
0

18. 5 Variables…
The Variables:
Number of Periods (N) 3
Interest rate (i) 10%
Present Value (PV) €100
Payment per Period (PMT) €40.21
Future Value (FV) €0

19. Loan of €100 – 3 years
(10%)
(€100)
(€80)
(€60)
(€40)
(€20)
€0
€20
€40
0 1 2 3
C
a
s
h
F
l
o
w
Years
€40.21 per year

20. Total Cost of Credit
1 Year 2 Years 3 Years
Repayment €110.0
0
€57.52 €40.21
No. of Years x 1 x 2 x 3
Total €110.0
0
€115.0
4
€120.6
3
Loan Value €100.0
0
€100.0
0
€100.0
0

21. 5 Variables…
The Variables:
Number of Periods (N) 5
Interest rate (i) 10%
Present Value (PV) €100
Payment per Period (PMT) €26.38
Future Value (FV) €0

22. Loan of €100 – 5 years
(10%)
(€100)
(€80)
(€60)
(€40)
(€20)
€0
€20
0 1 2 3 4 5
C
a
s
h
F
l
o
w
Years
€26.38 per year

23. Total Cost of Credit
1 Year 2 Years 3 Years 5 years
Repayment €110.0
0
€57.52 €40.21 €26.38
No. of Years x 1 x 2 x 3 x 5
Total €110.0
0
€115.0
4
€120.6
3
€131.9
0
Loan Value €100.0
0
€100.0
0
€100.0
0
€100.0
0

24. 5 Variables…
The Variables:
Number of Periods (N) 10
Interest rate (i) 10%
Present Value (PV) €100
Payment per Period (PMT) €16.27
Future Value (FV) €0

25. Loan of €100 – 10 years
(10%)
(€100)
(€80)
(€60)
(€40)
(€20)
€0
€20
0 1 2 3 4 5 6 7 8 9 10
C
a
s
h
F
l
o
w
Years
€16.27 per year

26. Total Cost of Credit
1 Year 2 Years 3 Years 5 years 10
years
Repayment €110.0
0
€57.52 €40.21 €26.38 €16.27
No. of Years x 1 x 2 x 3 x 5 x 10
Total €110.0
0
€115.0
4
€120.6
3
€131.9
0
€162.70
Loan Value €100.0
0
€100.0
0
€100.0
0
€100.0
0
€100.00

27. As the Term Increases
Repayments reduced
More time to repay
Total Cost of Credit increases
More borrowed for longer
Bank’s Exposure increases
More later

28. In Summary
1 Year 2 Years 3 Years 5 years 10
years
Repayment €110.0
0
€57.52 €40.21 €26.38 €16.27
No. of Years x 1 x 2 x 3 x 5 x 10
Total €110.0
0
€115.0
4
€120.6
3
€131.9
0
€162.70
Loan Value €100.0
0
€100.0
0
€100.0
0
€100.0
0
€100.00

29. 5 Variables…
The Variables:
Number of Periods (N)
Interest rate (i)
Present Value (PV)
Payment per Period (PMT)
Future Value (FV)
Interest Calculations
How many payments per year?
How often is interest charged?
Compounding

30. Compounding…
Daily Interest Rate:
Late Payment of CAT
A mere 0.0219% per day!
What is the APR?
The rate if interest was compounded once a year
1+
0.0219
100
æ
è
ç
ö
ø
÷
365
=1.083207 » 8.32%

31. CAT 2012 & 2016…
1+
0.0219
100
æ
è
ç
ö
ø
÷
365
=1.083207 » 8.32%
1+
0.0219
100
æ
è
ç
ö
ø
÷
366
=1.084444 » 8.34%
Leap Year – 366 days

32. Compounding…
More Frequent
Charging
Higher Effective Rate
Example
Rate of 10%
PV = 100
No payments in the
year
Calculate the Future
Value (FV)
Effect of Compounding
Once a Year
Twice a year?
Once a Quarter?
Once a Month?

33. Loan of €100 – 1 year
(10%)
(€100)
(€50)
€0
€50
€100
0 1
C
a
s
h
F
l
o
w
Years
€110 in the year

35. Impact of Compounding…

36. The Formula
1+
Rate
CompoundPeriods
æ
è
ç
ö
ø
÷
CompoundPeriods
-1
1+
0.10
2
æ
è
ç
ö
ø
÷
2
-1=1.052
-1=1.1025-1= 0.1025 =10.25%
1+
0.10
4
æ
è
ç
ö
ø
÷
4
-1=1.0254
-1=1.103812891-1= 0.103812891»10.38%

37. What Drives the Rate?
Costs of Funds
Cost of Borrowing
Risk
Credit Risk
Interest Rate Risk
Capital Required (driven by Risk)
Equity: Dearer than Debt
Expenses
Administration
Profit Margin

38. Cost of Funds
Liquidity Preference Theory (JM Keynes)
Transactions Motive
Cash for Pints!
Parking
Precautionary Motive
Rainy Day
Speculative Motive
Speculation
Supply & Demand
Inter-Bank Liquidity

39. What will it Cost to
Borrow?
Bank of Ireland
Homeloan Variable Rates for existing customers
Variable VRP15 – all amounts, all LTVs
3.85% (APR: 3.9%)
Lending criteria and terms and conditions apply. Security and insurance required. The maximum
mortgage is normally 90% of the property value. As a general rule, mortgage amounts up to 4-5
times an individual's gross annual income are considered and will vary according to individual
circumstances. A typical variable rate mortgage of €100,000 over 20 years costs €596.94 per
month (Annual Percentage Rate (APR) 3.9%). The cost of your monthly repayments may
increase. A 1% interest rate rise will increase this repayment to €650.08 (APR4.9%). This is an
increase of €53.14 per month. Information correct as at the 19th December 2011. Bank of Ireland
Mortgage Bank is a member of Bank of Ireland Group. Bank of Ireland and Bank of Ireland
Mortgage Bank, trading as Bank of Ireland Mortgages are regulated by the Central Bank of
Ireland.
http://personalbanking.bankofireland.com/mortgages/first-time-buyers-package#rates-accordion

40. Lending criteria and terms and conditions apply. Security and insurance required. The maximum
mortgage is normally 90% of the property value. As a general rule, mortgage amounts up to 4-5
times an individual's gross annual income are considered and will vary according to individual
circumstances. A typical variable rate mortgage of €100,000 over 20 years costs €596.94 per
month (Annual Percentage Rate (APR) 3.9%). The cost of your monthly repayments may
increase. A 1% interest rate rise will increase this repayment to €650.08 (APR4.9%). This is an
increase of €53.14 per month. Information correct as at the 19th December 2011. Bank of Ireland
Mortgage Bank is a member of Bank of Ireland Group. Bank of Ireland and Bank of Ireland
Mortgage Bank, trading as Bank of Ireland Mortgages are regulated by the Central Bank of
Ireland.
http://personalbanking.bankofireland.com/mortgages/first-time-buyers-package#rates-accordion
Real Rates

41. Time Value of Money
NPV & IRR

42. Time Value of Money
Money Today
Is worth more than money tomorrow!
How much?
What is your “exchange rate”?
TVM Game

43. NPV: Would you buy this?
(€1,000)
€100
€200
€300
€400
€300
(€1,000)
(€750)
(€500)
(€250)
€0
€250
€500
0 1 2 3 4 5
C
a
s
h
F
l
o
w
Years

44. Discount Rate & Value
-€150
-€100
-€50
€0
€50
€100 IRR
The rate which yields an NPV of €0!
In this case, the IRR is 8.01%

45. Risk!

46. What Drives the Rate?
Costs of Funds
Cost of Borrowing
Risk
Credit Risk
Interest Rate Risk
Capital Required (driven by Risk)
Equity: Dearer than Debt
Expenses
Administration
Profit Margin

47. Loan of €100 – 1 year
(10%)
(€100)
(€50)
€0
€50
€100
0 1
C
a
s
h
F
l
o
w
Years
€110 in the year

48. Impact of Risk
OK Total
Nominal €110.0
0
Probability 1.0
Expected Return €110.0
0
€110.0
0
Interest Rate 10%
Value of Debt €100.0
0Value =
Expected Return
1+rate( )
=
€ 110
1.10
= € 100

49. Impact of Risk
OK Default Total
Nominal €110.0
0
€0.00
Probability 0.8 0.2
Expected Return €88.00 €0.00 €88.00
Interest Rate 10%
Value of Debt €80.00
You would pay €80 for a loan note paying 10%
with a 20% probability of default
Value =
Expected Return
1+rate( )
=
€ 88
1.10
= € 80

50. What is the Interest Rate?
OK Default Total
Nominal €110.0
0
€0.00
Probability 0.8 0.2
Expected Return €88.00 €0.00 €88.00
Interest Rate 10%
Value of Debt €80.00
€110 €80
Interest =
PromisedReturn
ValueOfDebt
=
€ 110
€ 88
= 37.5%

52. €uro Bonds
Bonds Denominated in
€uro
No currency risk
Issued by Different
Countries
Credit Risk
Germany – Best
Greece – Worst
March 3rd
Germany 1.81% 1.92
%
Greece 38.8% 37.1
%
February 25th 2012

53. What Drives the Rate?
Costs of Funds
Cost of Borrowing
Risk
Credit Risk
Interest Rate Risk
Capital Required (driven by Risk)
Equity: Dearer than Debt
Expenses
Administration
Profit Margin

54. Expenses & Profit
Banks are in Business to Make Profit!
Cover Expenses
Yield a Profit
How priced
Included in the Margin

55. What Happens when
Variables Change?
The main restructure options!

56. 5 Variables…
The Variables:
Number of Periods (N)
Interest rate (i)
Present Value (PV)
Payment per Period (PMT)
Future Value (FV)
This is a term extension

57. Term Extension
Monthly Repayments
Fall
Increase Affordability
Term Increases!
Balance Outstanding Increases
Example
€100,000 @ 5% over 20 years
Becomes…
€100,000 @ 5% over 25 years
Should the Rate be the same?

58. Longer Term
Greater Risk

59. Effect of Term Extension
€0
€20,000
€40,000
€60,000
€80,000
€100,000
0 1 2 3 4 5 6 7 8 9 10111213141516171819202122232425

60. Effect of Term Extension
€0
€20,000
€40,000
€60,000
€80,000
€100,000
0 1 2 3 4 5 6 7 8 9 10111213141516171819202122232425

61. Effect of Term Extension
€0
€20,000
€40,000
€60,000
€80,000
€100,000
0 1 2 3 4 5 6 7 8 9 10111213141516171819202122232425
This is your new loan

62. Effect of Term Extension
€0
€5,000
€10,000
€15,000
€20,000
€25,000
€30,000
€35,000
0 2 4 6 8 10 12 14 16 18 20 22 24

63. 5 Variables…
The Variables:
Number of Periods (N)
Interest rate (i)
Present Value (PV)
Payment per Period (PMT)
Future Value (FV)
This is a Bullet Repayment
( “split” mortgage)

64. Bullet Repayment
Monthly Repayments
Fall
Increase Affordability
Term?
May Increase
Alternative Source of Repayment?
Balance Outstanding Increases
Example
€100,000 @ 5% over 20 years
Becomes…
€100,000 @ 5% over 20 years owing €30k in year 20!
Should the Rate be the same?

65. Effect of Bullet Repayment
€30,719
€0
€5,000
€10,000
€15,000
€20,000
€25,000
€30,000
€35,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Source of Repayment:
Asset Sale?
Pension Lump Sum?
Inheritance?
Term Extension?

66. Probability of Default
The risk you will have a default
Risk of a failure
What drives risk?
Many Factors…
Length of a loan!

67. If every payment has a 1%
chance of default…
0.00
0.25
0.50
0.75
1.00
1 13 25 37 49 61 73 85 97 109121133145157169181193205217229
Default

68. If every payment has a 0.1%
chance of default…
0.00
0.25
0.50
0.75
1.00
1 13 25 37 49 61 73 85 97 109121133145157169181193205217229
Default

69. If every payment has a 0.01%
chance of default…
0.960
0.965
0.970
0.975
0.980
0.985
0.990
0.995
1.000
1 13 25 37 49 61 73 85 97 109121133145157169181193205217229
Default

70. If every payment has a
0.001% chance of default…
0.9960
0.9965
0.9970
0.9975
0.9980
0.9985
0.9990
0.9995
1.0000
1 13 25 37 49 61 73 85 97 109121133145157169181193205217229
Default

71. Loss Given Default
Security?
Default does not mean total loss
Exposure at Default
Security
Other Costs

72. Summary
“Kicking the Can”
Not always the right answer
Risk
Length of a loan
Riskiness of a repayment
The more repayments…
The greater the overall risk
Asset Value
Cover: “positive” equity
Asset value vs loan value

73. It’s a Fixed Rate!
What Happens?

74. Fixed Rate Lending
Fixed Rates Provide Certainty
Customer Knows Repayment Amount
Risk?
Interest Rates Change!
Rates Go Up…
Bank Loses money
Rates Go Down…
Bank Makes Money
Manage Interest Rate Risk
Interest Rate Swap

75. How Does a Swap Work?
Counterparty A BANK Counterparty B
VariableVariable
Fixed Fixed
Investors
Receive Fixed
Investors
Receive Variable

76. How Does a Swap Work?
Counterparty A BANK Counterparty B
VariableVariable
Investors
Receive Fixed
Investors
Receive Variable
5% 5%

77. Fixed
How Does a Swap Work?
Counterparty A BANK
Fixed Rate
Mortgage
Holder
Variable
Variable
Fixed
Fixed
Investors
Receive Fixed
Bank Depositor
Variable
Counterparty B
Interest Rate
Risk is “Locked Out”

78. How Does a Swap Work?
Counterparty A BANK
Variable
Investors
Receive Fixed
Variable
Counterparty B
Interest Rate
Risk is “Locked Out”
5% Fixed3%
The Replacement Swap is at 3%... not 5%.

79. What is the Cost?
The Mortgage was 5%
The new counterparty is 3%
Gap 2%
What is the Break Cost?
Let’s use the Earlier Example
20 year Mortgage
5%
€100,000

80. Expected Balances
€0
€20,000
€40,000
€60,000
€80,000
€100,000
0 1 2 3 4 5 6 7 8 9 1011121314151617181920
20 years

81. Fixed Interest Payment
€0
€1,000
€2,000
€3,000
€4,000
€5,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Loss
New Amt

82. Interest Lost…
€0
€500
€1,000
€1,500
€2,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Loss

83. The Value of Break Costs
Period New Amt Loss 5% PV Value
0 €3,000 €2,000 1 €2,000
1 €2,909 €1,940 0.952381 €1,848
2 €2,814 €1,876 0.907029 €1,702
3 €2,714 €1,809 0.863838 €1,563
4 €2,609 €1,739 0.822702 €1,431
5 €2,499 €1,666 0.783526 €1,305
6 €2,383 €1,589 0.746215 €1,186
7 €2,261 €1,508 0.710681 €1,072
8 €2,134 €1,422 0.676839 €962
9 €2,000 €1,333 0.644609 €859
10 €1,859 €1,239 0.613913 €761
11 €1,711 €1,141 0.584679 €667
12 €1,556 €1,037 0.556837 €577
13 €1,393 €929 0.530321 €493
14 €1,222 €815 0.505068 €412
15 €1,042 €695 0.481017 €334
16 €854 €569 0.458112 €261
17 €656 €437 0.436297 €191
18 €448 €298 0.415521 €124
19 €229 €153 0.395734 €61
20 €0 €0 0.376889 €0
Total €24,195 €17,807
0.822702 × €1,739 = €1,431
1
1+0.05( )
4
= 0.822702

84. How to Value Break Costs
Interest Lost
Calculate
Take the Present Value
Amortising Swaps
Difficult to Value
Our Example is simplified!
For Example, the 5% is a bit more complicated!!
“Break” Costs
CPC Rules

85. Restructuring | Difficult
Quantitative
Risk & Interest Rate
Term Extension
Bullets
Fixed Rates
Qualitative
The “Story”
Other Data
Empathy
Understanding
“This is the toughest job in the bank” – Anon lender