Finance Policy and Practise Essay Example | Topics and Well Written Essays - 1750 words

Finance Policy and Practise - Essay Example The LTV ratio is used to determine whether the borrower is likely to default. A borrower who is considered rational is likely to default when the value of the collateral falls below the value of the loan by an amount which equates to the net cost of the transactions such as relocation expenses, future payments for being deficient and the stigma attached to the situation (Crawford and Rosenblatt 1995, cited in Qi and Yang 2009). There are various ways in which a bank such as VB may become exposed to default and these are matters to be discussed. 1.1 Assessment of Estimated Property Values In assessing the value of a property and the annual rental price a number of formulas are used. The gross rent yield and the price/rent ratio are very useful formulas. Global Property Guide (2012) indicates that the gross rental yield on UK properties is 3.43% and the price rent ratio is 29 yrs. The price/rent ratio was used to calculate the property values and the gross rental yield was used to calc ulate the rental. ... -to-value (LTV) ratios and interest cover (the number of times interest is covered by rental income) will be used to assess Virtual Bank’s existing property loan portfolio. 2.1 Loan-to-Value Ratio The loan-to-value (LTV) ratio is the standard risk measure that is used by lending institutions to analyse the risk attached to their loan portfolio. The formula for calculating LTV is: current value of property/loan. LTVs are rated as high, moderate or low. LTV’s in excess of 80% are considered high, 60 to 80% moderate and below 60% low. The information on sheet 1 shows that the LTV ratios after the revaluation are between 15.8% and 52.9%. This means that loans are properly secured and so VB faces no major risks as borrowers are not likely to default under the current valuation. 2.2 Assessment of Interest Cover The interest cover represents the number of times interest is covered by the operating profit from the property. The formula is operating profit before interest and ta x (PBIT)/interest expenses. Interest cover of 3 times or more are generally considered acceptable while 2 times and under are considered low (BPP 2009). The information on the spreadsheet labelled Sheet 3 indicates that the interest cover for all but three (3) loans is in the acceptable range of between 3 and 16 times. However, the loans to Plane (5,100), Russet (4,000), and Pearmain (8,000) show interest cover of 2.4, 2.1 and 2.5 respectively. These loans represent 4% ((17,100/428,448)*100) of the total loans drawn. This is a small percentage and there is no cause for a major concern because the interest cover although not in the acceptable region is still above 2. 3.0 Strategy for risk reduction The overall risk on the loan portfolio is considered low. However, there are some strategies that can be