5.2 Assessment of borrower’s creditworthiness

Institutions should analyse the loan application of the borrower in order to ensure that the application is in line with the institutions’ credit risk appetite, policies, credit-granting criteria, limits and relevant metrics, as well as any relevant macroprudential measures where applied by the designated macroprudential authority.

Institutions and creditors should, in line with the relevant consumer protection legislation, assess the borrower’s ability and prospect to meet the obligations under the loan agreement, covering, in particular, an assessment of the borrower’s source of repayment capacity, taking into account specificities of the loan, such as nature, maturity and interest rate.

Collateral, in the case of secured lending, by itself should not be a predominant criterion for approving a loan and cannot by itself justify the approval of any loan agreement. Collateral should be considered the institution’s second way out in case of default or material deterioration of the risk profile, and not the primary source of repayment, with the exception of when the loan agreement envisages that the repayment of the loan is based on the sale of the property pledged as collateral or liquid collateral provided.

When assessing the borrower’s ability to meet obligations under the loan agreement, institutions and creditors should take into account relevant factors that could influence the present and future repayment capacity of the borrower, and should avoid inducing undue hardship and over-indebtedness. The factors should include other servicing obligations, their remaining duration, their interest rates and the outstanding amounts, and repayment behaviour, e.g. evidence of any missed payments and their circumstances, as well as directly relevant taxes and insurance if known.

If the loan application is submitted jointly by more than one borrower, institutions and creditors should perform the creditworthiness assessment on the basis of the joint repayment capacity of the borrowers.

If a loan agreement involves any form of guarantees from third parties, institutions should assess the level of protection provided by the guarantee, and if relevant, conduct a creditworthiness assessment of the guarantor, applying the relevant provisions of these guidelines, depending on whether the guarantor is a natural person or an enterprise.

For assessing the borrower’s ability to meet obligations under the loan agreement, institutions and creditors should adopt suitable methods and approaches, which may include models, as long as these guidelines are met. The selection of the suitable and adequate method should depend on the risk level, size and type of loan.

5.2.2 Lending to consumers in relation to residential immovable property

This section further specifies factors relevant to assessing the prospect of the borrower to meet obligations under a loan agreement as referred to in Article 18(1) and 20(1) of Directive 2014/17/EU. In relation to loan agreements subject to national laws transposing that Directive, institutions and creditors should apply, in addition to provisions set out in Section 5.2.1, provisions set out in this section.

When necessary, in particular in cases of borrowers who are self-employed or have seasonal or other irregular income, institutions and creditors should make reasonable enquiries and take reasonable steps to verify the information regarding the source of repayment capacity.

If the loan term extends past the borrower’s expected retirement age, institutions and creditors should take appropriate account of the adequacy of the borrower’s likely source of repayment capacity and ability to continue to meet obligations under the loan agreement in retirement.

Institutions and creditors should ensure that the borrower’s ability to meet obligations under the loan agreement is not based on an expected significant increase in the borrower’s income, unless the documentation provides sufficient evidence.

When assessing the borrower’s ability to meet obligations under the loan agreement, institutions and creditors should account for committed and other non-discretionary expenditures, such as the borrower’s current obligations, including appropriate substantiation and consideration of living expenses.

As part of the creditworthiness assessment, institutions and creditors should carry out sensitivity analyses reflecting potential negative events in the future, including a reduction in income; an increase in interest rates in cases of variable rate loan agreements; negative amortisation of the loan; and balloon payments or deferred payments of the principal or interest.

In cases of foreign currency loans as defined in Article 4(28) of Directive 2014/17/EU, institutions and creditors should also factor into the assessment of the borrower’s capacity to meet the obligations potential negative scenarios of the exchange rate between the currency of the borrower’s income and the currency of the loan. Institutions and creditors should also take into account and assess any hedging strategies and actual hedges in place, including natural hedges, to mitigate foreign currency exchange risk.

For loan agreements that relate to an immovable property that explicitly state that the immovable property is not to be occupied as a place of residence by the borrower or a family member (i.e. buy-to-let agreements) as referred to in point (b) of Article 3(3) of Directive 2014/17/EU, institutions and creditors should apply the criteria set out in Section 5.2.3.

5.2.3 Other secured lending to consumers

In relation to loan agreements secured by immovable property, other than those covered in Section 5.2.2, institutions and creditors should apply, in addition to the provisions set out in Section 5.2.1, provisions set out in this section.

If the property is still being constructed and intended to provide, upon completion, an income to its owner in the form of rents or profits from its sale, institutions should assess the development phase and the phase after the completion of the development, when the project converts into an income-producing property. For the purposes of such loan agreements, institutions and creditors should establish that:

• a. the borrower has a plausible plan related to the project, including estimates of all costs associated with the development;
• b. the borrower has access to builders, architects, engineers and contractors, who will take part in the development;
• c. the borrower has obtained or is able to obtain in the future all necessary permits and certificates for the development, as the project progresses.

For loan agreements that relate to an immovable property that explicitly state that the immovable property is not to be occupied as a place of residence by the borrower or a family member (i.e. buy-to-let agreements), institutions should assess the relationship between the future rental income from the immovable property and the borrower’s ability to meet obligations.

As part of the creditworthiness assessment, institutions should carry out sensitivity analyses to reflect potential negative market and idiosyncratic events in the future that are relevant to the type and purpose of the loan. These events may include a reduction in income; an increase in interest rates in cases of variable rate loan agreements; negative amortisation of the loan; balloon payments or deferred payments of the principal or interest; and, when relevant, deterioration in the marketability of the immovable property, an increase in vacancy rates and a reduction in the rental prices for similar properties. When relevant, institutions and creditors should also consider the implication of foreign currency exchange rate risk, as provided in paragraph 108.

5.2.4 Unsecured lending to consumers

This section further specifies the requirements to assess the creditworthiness of the borrower referred to in Article 8 of Directive 2008/48/EC. In relation to loan agreements subject to national laws transposing that Directive institutions and creditors should apply, in addition to provisions set out in Section 5.2.1, provisions set out in this section.

Where necessary, in particular in cases of borrowers who are self-employed or have seasonal or other irregular income, institutions and creditors should make reasonable enquiries and take reasonable steps to assess and verify the source of repayment capacity.

Institutions and creditors should ensure that the borrower’s ability to meet obligations under the loan agreement is not based on an expected significant increase in the borrower’s income, unless the documentation provides sufficient evidence.

As part of the creditworthiness assessment, institutions and creditors, if applicable, should carry out sensitivity analyses to reflect potential negative events specific to the type of loan that may occur in the future. When relevant, institutions and creditors should also consider the implication of foreign currency exchange rate risk, as provided in paragraph 108.

5.2.5 Lending to micro and small enterprises

Institutions should assess the borrower’s current and future ability to meet the obligations under the loan agreement. Institutions should also analyse the loan application of the borrower in order to ensure that the application is in line with the institution’s credit risk appetite, policies, credit-granting criteria, limits and relevant metrics, as well as any relevant macroprudential measures, where applied by the designated macroprudential authority.

Institutions should consider that cash flow from the ordinary business activities of the borrower and, when applicable within the purpose of the loan agreement, any proceeds on the sale of the assets are the primary sources of repayment.

When assessing the creditworthiness of the borrower, institutions should put emphasis on the borrower’s realistic and sustainable future income and future cash flow, and not on available collateral. Collateral by itself should not be a predominant criterion for approving a loan and cannot by itself justify the approval of any loan agreement. Collateral should be considered the institution’s second way out in case of default or material deterioration of the risk profile, and not the primary source of repayment, with the exception of when the loan agreement envisages that the repayment of the loan is based on the sale of the property pledged as collateral or liquid collateral provided.

When carrying out the creditworthiness assessment, institutions should:

• a. analyse the financial position and credit risk of the borrower, as set out below;
• b. analyse the business model and strategy of the borrower, as set out below;
• c. determine and assess the borrower’s credit scoring or internal rating, where applicable, in accordance with the credit risk policies and procedures;
• d. consider all the borrower’s financial commitments, such as drawn and undrawn committed facilities with institutions, including working capital facilities, credit exposures of the borrower and the past repayment behaviour of the borrower, as well as other obligations arising from tax or other public authorities or social security funds;
• e. when relevant, assess the structure of the transaction, including the risk of structural subordination and related terms, e.g. covenants, and, if applicable, third-party guarantees and collateral structure.

Institutions should carry out the creditworthiness assessment in relation to the specificities of the loan, such as nature, maturity and interest rate.

For assessing the borrower’s ability to meet obligations under the loan agreement, institutions should adopt suitable methods and approaches, which may include models, as long as these guidelines are met. The selection of the suitable and adequate method should depend on the risk level, size and type of loan.

If the borrower is a member of a group of connected clients, institutions should carry out the assessment at individual level and, where relevant, at group level, in accordance with the EBA Guidelines on connected clients, especially when repayment is reliant on cash flow emanating from other connected parties. If the borrower is a member of a group of connected clients linked to central banks and sovereigns, including central governments, regional and local authorities, and public sector entities, institutions should assess the individual entity.

For lending activities with cross-border elements (e.g. trade finance, export finance), institutions should take into account the political, economic and legal environment in which the foreign counterparty of the institution’s client operates. Institutions should assess the buyer’s ability to transfer funds, the supplier’s capacity to deliver the order, including its capacity to meet the applicable local legal requirements, and the supplier’s financial capacity to handle possible delays in transaction.

Institutions should assess the borrower’s exposure to ESG factors, in particular environmental factors and the impact on climate change, and the appropriateness of the mitigating strategies, as set out by the borrower. This analysis should be performed on a borrower basis; however, when relevant, institutions may also consider performing this analysis on a portfolio basis.

In order to identify borrowers that are exposed, directly or indirectly, to increased risk associated with ESG factors, institutions should consider using heat maps that highlight, for example, climate-related and environmental risks of individual economic (sub-)sectors in a chart or on a scaling system. For loans or borrowers associated with a higher ESG risk, a more intensive analysis of the actual business model of the borrower is required, including a review of current and projected greenhouse gas emissions, the market environment, supervisory ESG requirements for the companies under consideration and the likely impacts of ESG regulation on the borrower’s financial position.

Analysis of the borrower’s financial position

For the purposes of the analysis of the financial position within the creditworthiness assessment as specified above, institutions should consider the following:

• a. both the current and the projected financial position, including balance sheets, source of repayment capacity to meet contractual obligations, including under possible adverse events, and, where relevant, capital structure, working capital, income and cash flow;
• b. where relevant, the borrower’s leverage level, dividend distribution, and actual and projected/forecasted capital expenditure, as well as its cash conversion cycle in relation to the facility under consideration;
• c. where relevant, the exposure profile until maturity, in relation to potential market movements, such as exposures denominated in foreign currencies and exposures collateralised by repayment vehicles;
• d. where applicable, the probability of default, based on credit scoring or internal risk rating;
• e. the use of appropriate financial, asset class-specific or product type-specific metrics and indicators, in line with their credit risk appetite, policies and limits set out in accordance with Sections 4.2 and 4.3, including considering metrics in Annex 3 to an extent that is applicable and appropriate to the specific credit proposal.

Institutions should ensure that the financial projections used in the analysis are realistic and reasonable. These projections/forecasts should be at least based on projecting historical financial data forward. Institutions should assess if these projections are in line with the institution’s economic and market expectations. When institutions have material concerns about the reliability of these financial projections, they should make their own projections of the borrowers’ financial position and repayment capacity.

If applicable, institutions should assess the financial position when granting loans to holding companies, both as a separate entity, e.g. at consolidated level, and as a single entity, if the holding company is not itself an operating company or institutions do not have guarantees from the operating companies to the holding company.

When assessing the borrowers’ financial position, institutions should assess the sustainability and feasibility of the future repayment capacity under potential adverse conditions that are relevant to the type and purpose of the loan and may occur in the duration of the loan agreement. These events may include a reduction in income and other cash flow; an increase in interest rates; negative amortisation of the loan; deferred payments of principal or interest; deterioration in the market and operating conditions for the borrower; and foreign currency exchange rate changes, when relevant.

Analysis of the borrower’s business model and strategy

Institutions should assess the business model and strategy of the borrowers, including in relation to the purpose of the loan.

Institutions should assess the borrower’s knowledge, experience and capacity to manage business activities, assets or investments linked to the loan agreements (e.g. specific property for a CRE loan).

Institutions should assess the feasibility of the business plan and associated financial projections, in line with the specificities of the sector in which the borrower operates.

Institutions should assess the borrower’s reliance on key contracts, customers or suppliers and how they affect cash flow generation, including any concentrations.

Institutions should assess the presence of any potential key-person dependency with regard to the borrower and, when necessary, identify, together with the borrower, possible mitigation measures. Assessment of guarantees and collateral

Institutions should assess any pledged collateral that is used for the purposes of risk mitigation against the requirements for collateral set out in the institution’s credit risk appetite, policies and procedures, including the valuation and ownership, and check all relevant documentation (e.g. whether property is registered in appropriate registers).

Institutions should assess any guarantees, covenants, negative pledge clauses and debt service agreements that are used for the purposes of risk mitigation.

When relevant to credit decisions, institutions should assess the borrower’s equity and credit enhancements, such as mortgage insurance, take-out commitments and repayment guarantees from external sources.

If a loan agreement involves any form of guarantees from third parties, institutions should assess the level of protection provided by the guarantee, and if relevant, conduct a creditworthiness assessment of the guarantor, applying the relevant provisions of these guidelines, depending on whether the guarantor is a natural person or an enterprise. The creditworthiness assessment of the guarantor should be proportionate to the size of the guarantee in relation to the loan and the type of guarantor.

5.2.6 Lending to medium-sized and large enterprises

Institutions should assess the borrower’s current and future ability to meet the obligations under the loan agreement. Institutions should also analyse the loan application of the borrower in order to ensure that the application is in line with the institution’s credit risk appetite, policies, credit-granting criteria, limits and relevant metrics, as well as any relevant macroprudential measures, where applied by the designated macroprudential authority.

Institutions should consider that cash flow from the ordinary business activities of the borrower and, when applicable within the purpose of the loan agreement, any proceeds on the sale of the assets are the primary sources of repayment.

When assessing the creditworthiness of the borrower, institutions should put emphasis on the borrower’s realistic and sustainable future income and future cash flow, and not on available collateral. Collateral by itself should not be a predominant criterion for approving a loan and cannot by itself justify the approval of any loan agreement. Collateral should be considered the institution’s second way out in case of default or material deterioration of the risk profile, and not the primary source of repayment, with the exception of when the loan agreement envisages that the repayment of the loan is based on the sale of the property pledged as collateral or liquid collateral provided.

When carrying out the creditworthiness assessment, institutions should:

• a. analyse the financial position and credit risk of the borrower, as set out below;
• b. analyse the organisational structure, business model and strategy of the borrower, as set out below;
• c. determine and assess the borrower’s credit scoring or internal rating, where applicable, in accordance with the credit risk policies and procedures;
• d. consider all the borrower’s financial commitments, such as all drawn and undrawn committed facilities with institutions, including working capital facilities, credit exposures of the borrower and the past repayment behaviour of the borrower, as well as other obligations arising from tax or other public authorities or social security funds;
• e. assess the structure of the transaction, including the risk of structural subordination and related terms, e.g. covenants, and, if applicable, third-party guarantees and collateral structure.

Institutions should carry out the creditworthiness assessment in relation to the specificities of the loan, such as nature, maturity and interest rate.

Institutions should assess the borrower’s exposure to ESG factors, in particular environmental factors and the impact on climate change, and the appropriateness of the mitigating strategies, as set out by the borrower.

If the borrower is a member of a group of connected clients, institutions should carry out the assessment at individual level and, where relevant, at group level, in accordance with the EBA Guidelines on connected clients, especially when repayment is reliant on cash flow emanating from other connected parties. If the borrower is a member of a group of connected clients linked to central banks and sovereigns, including central governments, regional and local authorities, and public sector entities, institutions should assess the individual entity.

For lending activities with cross-border elements (e.g. trade finance, export finance), institutions should take into account the political, economic and legal environment in which the foreign counterparty of the institution’s client operates. Institutions should assess the buyer’s potential to transfer funds, the supplier’s capacity to deliver the order, including its capacity to meet the applicable local legal requirements, and the supplier’s financial capacity to handle possible delays in transaction.

In order to identify borrowers that are exposed, directly or indirectly, to increased risks associated with ESG factors, institutions should consider using heat maps that highlight, for example, climate-related and environmental risks of individual economic (sub-)sectors in a chart or on a scaling system. For loans or borrowers associated with a higher ESG risk, a more intensive analysis of the actual business model of the borrower is required, including a review of current and projected greenhouse gas emissions, the market environment, supervisory ESG requirements for the companies under consideration and the likely impacts of ESG regulation on the borrower’s financial position.

Analysis of the borrower’s financial position

For the purposes of the analysis of the financial position within the creditworthiness assessment as specified above, institutions should consider the following:

• a. both the current and the projected financial position, including balance sheets and capital structure, working capital, income, cash flow and the source of repayment capacity to meet contractual obligations, e.g. debt-servicing capacity, including under possible adverse events (see also sensitivity analysis) – items to be analysed should include but not be limited to free cash flow available for debt servicing of the facility under consideration;
• b. net operating income and profitability, especially in relation to interest-carrying debt;
• c. the borrower’s leverage level, dividend distribution, and actual and projected capital expenditure, as well as its cash conversion cycle in relation to the facility under consideration;
• d. the exposure profile until maturity, in relation to potential market movements (e.g. exposures denominated in foreign currencies and exposures collateralised by repayment vehicles);
• e. where applicable, the probability of default, based on credit scoring or internal risk rating;
• f. the use of appropriate financial, asset class- or product type-specific metrics and indicators, in line with their credit risk appetite, policies and limits set out in accordance with Sections 4.2 and 4.3, including considering metrics in Annex 3 to an extent that is applicable and appropriate to the specific credit proposal.

Institutions should ensure that the projections used in the analysis are realistic and reasonable and are in line with the institutions’ economic and market expectations. When institutions have material concerns about the reliability of these financial projections, they should make their own projections of the borrowers’ financial position and, when relevant, use them to challenge the projections provided by the borrowers.

Institutions should also assess the borrower’s capacity for future profitability, to measure the impact of retained earnings and hence the impact on equity, particularly in cases where the borrower has been unable to generate positive profits over time.

Institutions should perform an assessment of the cash conversion cycle of the borrower, to measure the time it takes for the business to convert the investment in inventory and other resource inputs into cash through the sale of its specific goods and services. Institutions should be able to understand the cash conversion cycle of a borrower to estimate working capital needs and identify recurring costs, in order to assess the ongoing capacity to repay credit facilities over time.

Institutions should, when relevant, assess these financial metrics against the metrics and limits set out in their credit risk appetite, credit risk policies and limits, in accordance with Sections 4.2 and 4.3.

Institutions should assess the financial position when granting loans to holding companies, both as a separate entity, e.g. at consolidated level, and as a single entity, if the holding company is not itself an operating company or institutions do not have guarantees from the operating companies to the holding company.

Sensitivity analysis in creditworthiness assessment

Institutions should assess the sustainability and feasibility of the borrower’s financial position and the future repayment capacity under potential adverse conditions that may occur in the duration of the loan agreement. To this end, institutions should carry out a single- or multifactor sensitivity analysis, considering market and idiosyncratic events, or a combination of any of them.

This sensitivity analysis should account for all general and asset class and product-specific aspects that may have an impact on the creditworthiness of the borrower.

When carrying out a sensitivity analysis of the borrower’s repayment capacity under negative future conditions, institutions should take into account the following events that are most relevant to the specific circumstances and the business model of the borrower:

Idiosyncratic events

• a. a severe but plausible decline in a borrower’s revenues or profit margins;
• b. a severe but plausible operational loss event;
• c. the occurrence of severe but plausible management problems;
• d. the failures of significant trading partners, customers or suppliers;
• e. a severe but plausible reputational damage;
• f. a severe but plausible outflow of liquidity, changes in funding or an increase in a borrower’s balance sheet leverage;
• g. adverse movements in the price of assets to which the borrower is predominantly exposed (e.g. as raw material or end product) and foreign exchange risk;

Market events

• h. a severe but plausible macroeconomic downturn;
• i. a severe but plausible downturn in the economic sectors in which the borrower and its clients are operating;
• j. a significant change in political, regulatory and geographical risk;
• k. a severe but plausible increase in the cost of funding, e.g. an increase in the interest rate by 200 basis points on all credit facilities of the borrower.

Analysis of the borrower’s business model and strategy

Institutions should assess the business model and strategy of the borrowers, including in relation to the purpose of the loan.

Institutions should assess the borrower’s knowledge, experience and capacity to manage business activities, assets or investments linked to the loan agreements (e.g. specific property for the CRE loan).

Institutions should assess the feasibility of the business plan and associated financial projections, in line with the specificities of the sector in which the borrower operates.

Institutions should assess the borrower’s reliance on key contracts, customers or suppliers and how they affect cash flow generation, including any concentrations.

Assessment of guarantees and collateral

Institutions should assess any pledged collateral against the requirements for collateral set out in the institution’s credit risk appetite, policies and procedures, including the valuation and ownership, and check all relevant documentation (e.g. whether property is registered in appropriate registers).

Institutions should assess any guarantees, covenants, negative pledge clauses and debt service agreements that are used for the purposes of risk mitigation. Institutions should also consider if the value of the collateral is in some way correlated with the borrower’s business or capacity to generate cash flow.

Institutions should assess the borrower’s equity and credit enhancements, such as mortgage insurance, take-out commitments and repayment guarantees from external sources.

If a loan agreement involves any form of guarantees from third parties, institutions should assess the level of protection provided by the guarantee and, if relevant, conduct a creditworthiness assessment of the guarantor, applying the relevant provisions of these guidelines, depending on whether the guarantor is a natural person or an enterprise. The creditworthiness assessment of the guarantor should be proportionate to the size of the guarantee in relation to the loan and the type of guarantor.

If, in the syndicated lending or project finance transactions, the payment streams pass through a third party to the transactions, e.g. a designated agent, institutions (or mandated lead arrangers or their nominated agents) should assess the soundness of the agent. For cross-border lending and project finance transactions, the agent should be the sole issuer of any guarantees, letters of credit or similar documents issued on behalf of the supplier in the transaction.

5.2.7 Commercial real estate lending

When assessing the creditworthiness of the borrowers in cases of CRE lending, in addition to the general criteria for the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should apply the specific criteria set out in this section. When assessing the creditworthiness of the borrowers in cases of lending for commercial real estate to be used by the borrower that owns the property for conducting business, institutions should apply the criteria set out in Section 5.2.5 and Section 5.2.6 only.

Institutions should assess and verify the borrower’s experience in relation to the type, size and geographical location of the CRE. When the borrower is a special purpose vehicle sponsored by another entity, institutions should assess the sponsoring entity’s experience in relation to the type, size and geographical location of the CRE.

Institutions should carry out an assessment of the income-producing capacity of the property and an assessment of the prospect of refinancing. These assessments should account for the committed term of the CRE loan under the loan application in question.

In the assessment of the borrower’s repayment capacity, institutions should assess, where relevant:

• a. the sustainability of the cash flow;
• b. the quality of the tenants, the impact of changes to current rental income on the amortisation schedule, lease terms, maturities and conditions, and payment history of the tenant if already in place;
• c. reletting prospects, the cash flow required to service the loan in accordance with the loan agreement if there are needs for reletting, if applicable the performance of the asset in an economic downturn, and fluctuations in rental yields over time, to assess the presence of overly compressed yields;
• d. necessary capital expenditure on the property throughout the term of the loan.

In the assessment of the prospects of reletting any property, institutions should account for tenants’ demand for that property, having regard to the supply of comparable properties, the conditions and specifications of the property, the location of the property and the proximity to relevant infrastructure serving the property.

When interest-only loans are advanced for CRE, institutions should assess property cash flow to support a level of amortisation equivalent to the projected economic life cycle of the property, to clear the principal amount and interest of the loan in the event of an increase in the loan to value (LTV) for the property, or to a regular LTV level in the relevant market. Institutions should also consider such analysis when borrowers have additional credit enhancements, e.g. disposal assets that are legally enforceable in a reasonable time period.

For the purposes of the sensitivity analysis under adverse market and idiosyncratic events, institutions should, in addition to the events specified in Section 5.2.5 and Section 5.2.6, take into account the following, as applicable:

• a. reletting, including a change in the rental prices, lease length in relation to loan term service charges, an increase in vacancy rates, maintenance and refurbishment costs, rent-free periods and letting inducement;
• b. risks and delays associated with refinancing;
• c. capital expenditure risk;
• d. other relevant criteria. 5.2.8 Lending for real estate development

When assessing the creditworthiness of the borrowers in cases of lending for real estate development, in addition to the general provisions on the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should apply the specific provisions of this section.

The creditworthiness assessment should cover, in line with the life cycle of the loan, both the development phase, including its stages, when relevant, and the phase after the completion of the development, when the project converts into a CRE loan. The latter stage should be assessed as CRE lending, in accordance with the provisions of these guidelines.

In the assessment of the development phase, institutions should establish that the borrower:

• a. has a plausible business plan, including a rationale for the development and a projection of all costs associated with the development verified by an independent expert;
• b. has access to builders, architects, engineers and contractors for the development of the real estate;
• c. has obtained or is able to obtain in the future all necessary permits and certificates for the development, as the project progresses and before disbursement(s).

Institutions should ensure that the calculation of costs associated with the development include contingencies for cost overruns. Planned contingencies should be included in the credit limit or equity. Institutions should assess the level of cash reserves and liquidity profile of the borrower to ensure that the borrower has the capacity to fund unplanned contingencies for cost overruns and delays, if any, above the contingency sum.

Institutions should perform an assessment of the feasibility of any projected net sale proceed projection, in terms of both value and volume of sales and timelines.

Institutions should carry out on-site visits, where relevant accompanied by a suitably qualified person, to verify the main components of the site, including access and site specificities, and retain a summary of the site visit in the file on the borrower.

In addition to assessing the creditworthiness of the borrower, institutions, when relevant (e.g. in cases of margin calls), should assess equity investors in the project, focusing on assessing their financial position, relevant expertise and experiences in similar projects, as well as the alignment of interests between the equity investors and the institutions offering lending to the same project.

5.2.9 Leveraged transactions

When assessing the creditworthiness of the borrowers in cases of leveraged transactions, in addition to the general provisions on the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should identify excessive leverage at origination, defined as a ratio: total debt to earnings before interest, taxes, depreciation and amortisation (EBITDA). Transactions with excessive leverage should remain exceptional (and should be in line with an institution’s risk appetite) and form part of the credit delegation and risk management escalation framework of an institution.

Institutions should conduct a comprehensive assessment of a borrower’s capacity to repay or deleverage to sustainable levels of debt within a reasonable period of time.

5.2.10 Shipping finance

When assessing the creditworthiness of borrowers in the case of shipping finance, in addition to the general provisions on the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should apply the specific criteria set out in this section. In particular, institutions should assess the following:

• a. the vessel’s earnings to costs (operation expenses, including insurance, wages, maintenance, lubricants and interest cost) ratio;
• b. the ratio of the vessel’s current age to its expected useful life;
• c. characteristics of the borrower’s fleet in relation to the global fleet population (the size of the new build activity, the number of vessels laid up, the number of vessels scrapped for each segment and the age of the vessels will determine over-tonnage and influence freight rates);
• d. vessel valuations with or without haircut (if those are included as a repayment source), to reflect selling costs, the time value of money and uncertainties regarding the liquidity and marketability of the asset, unless single valuations are not possible if vessels are operated as part of a larger fleet with widely different types of earnings.

Institutions should also consider other factors, such as the supply and demand in the market for the type of vessel in question, present and future trade patterns for the type of vessel in question, the necessity for the loan to be non-recourse or have guarantees, or have a long-term charter with an acceptable end user, and if the ship owner can provide other securities, such as assignments of charters and insurances, charges of shares and cash collateral or mortgages of other assets, such as real property and sister vessels.

In the case of loans to shipbuilding, institutions should establish that the borrower:

• a. has a plausible business plan, including a rationale for the development and a projection of all associated costs verified by an independent expert;
• b. has access to builders, marine architects, engineers and shipbuilding contractors;
• c. has obtained or is able to obtain in the future all necessary permits and certificates for the development, as the project progresses. 5.2.11 Project finance

When assessing the creditworthiness of the borrowers in cases of project finance, in addition to the general provisions on the creditworthiness assessment set out in Section 5.2.5 and Section 5.2.6, institutions should follow the specific criteria of this section.

Institutions should assess the primary source of repayment of the loan, which is the income generated by the assets (project) being financed. Institutions should assess the cash flow associated with the project, including future income-producing capacity once the project is completed, taking into account any applicable regulatory or legal restriction (e.g. price regulation, rate-of-return regulation, revenues being subject to take-or-pay contracts, environmental legislation and regulations affecting the profitability of a project).

As far as possible, institutions should ensure that all the assets of the project and the present and future cash flow and accounts are pledged to the institution providing the lending or to the agent/underwriter in the case of a syndicated transaction/club deal. If a special purpose vehicle is established for the project, the shares in that special purpose vehicle should be pledged to the institution, to enable the institution/agent to take possession of the company if needed. In cases of syndicated transactions/club deals, inter-creditor agreements should regulate each creditor’s access to pledged funds and assets.

In the assessment of the development phase of the project, institutions should establish that the borrower:

• a. has a plausible business plan, including a rationale for the development and a projection of all costs associated with the development verified by an independent expert;
• b. has access to builders, architects, engineers and contractors for the project;
• c. has obtained or is able to obtain in the future all necessary permits and certificates for the development, as the project progresses.

Institutions should ensure that the calculation of costs associated with the development, as provided by the borrower, includes contingencies for cost overruns. Such planned contingencies should be included in the credit limit or equity. Institutions should assess the level of cash reserves and liquidity profile of the borrower or equity investors to ensure that they have the capacity to fund unplanned contingencies for cost overruns and delays, if any, above the contingency sum.

In addition to assessing the creditworthiness of the borrower, institutions should assess equity investors in the project, focusing when relevant on assessing their financial position, relevant expertise, experiences in similar projects, ability and willingness to support the project over the project’s lifetime.