Loans

 G&K, Chps. 9 & 10  Economic Environment  Commercial and Industrial Lending  Real Estate and Consumer Lending

Economic Environment  Pattern of Interest Rates with unfolding Business Cycle.  Predict Business Cycle (Trough, Growth, Boom, Peak, Slowdown, Recession, Trough……)  Pattern of Interest Rates  1-period ahead relatively easy (Simulation)  Discussion here is expectation 2 + periods ahead…….

Business Cycle and Interest Rates  Trough: Low economic activity; low demand for funds, high demand for safe, liquid investments  Low relative rates, + curve  Growth to Peak: Increasing economic activity; high demand for funds, low demand for interest-rate investments  Higher relative rates, + to flattening curve  Slowdown  Trough; Slowing economic activity, early high demand for funds gives rise to drop off  High rates drop, with inverted-curve returning to positive slope

Commercial Lending  Asymmetric Information (AI) gives: Adverse Selection: The reason bad borrowers are coming to banks is they can’t get capital elsewhere, but AI makes it hard to separate from good borrowers Moral Hazard: Given loan granted, higher-risk activities may be substituted to gain extra return that goes to owners, not loan….MONITOR!

The Business Dynamics of Loans  Trade-off between: Interest and fees gained, and Credit Risk of default and costs  Types: Lines of Credit, Term Loans, Bridge Loans  Technology has buffered: Securitization of loans: Mtgs, Cars, CCs Credit Scoring and Credit Risk transfer

Definition of Collateral  Reduces Risk, but Increases Monitoring  Characteristics of good collateral: Durability is the ability of the asset to withstand wear. Durable versus nondurable collateral. Identification due to physical uniqueness or serial numbers. Marketability of the property if resold. Stability of value over the period of the loan. Standardization by government or industry guidelines in grading quality of assets.

Types of Collateral  A/R – Pledging or Factoring  Inventory  Securities  Property or Equipment  Loan Guarantees – US Gov’t, State

Lending Evaluation  Six C’s: Character (personal traits) Capacity (cash flows) Capital (net worth) Collateral (pledged assets) Conditions (economic conditions) Compliance (Legal standing)

Methods of Pricing  Markup – BPs over index (prime)  Cost of Funds – WACC + Profit Goal  Relationship – Not just loan, but fees made elsewhere as an offset  Match funding – BPs over match funds cost of money  Adjustable rate – not just market yields, but also risk changes Requires extra monitoring and compliance review……

Real Estate  Residential, Commercial, Farm, Multi-family  Origination, Securitization and Servicing  Brokering, Securitization Resale and Real Estate Industry assistance

Real Estate Loan Characteristics  Downpayment: 5, 10, 20% <20% usually requires Private Mortgage Insurance (PMI)  Loan then for (RE value-DownPymt)  Prepay makes std 30 year mortgage into an average 7-12 year loan.  Falling interest rates can make this average even shorter.  RE good loan as well collateralized

Residential RE Loan Terms  Guarantor: FHA, VA (as little as 3% down!)  Rates: Fixed, 30 vs. 15, ARMs ARMs:  3 and 1, 5 and 1, X and Y……  Index, Caps, Resets  Other Terms: Buydowns, Assumables, Balloons, Points, Graduated Payments (GPMs), Growing Equity (GEMs), Shared Apprec

Commercial Real Estate  Land, construction and real estate development, and commercial properties  Construction loans: Disbursements over time as project completed Usually of “Bridge” variety Land serves as collateral for loans. Pricing Prime Plus Origination as high as 3 Points

Consumer Lending  Personal Loans  Small Dollar, usually no collateral  Open Lines (CC) or Closed (Auto/Boat)  Higher Risk  Higher Rate  Attempt to diversify geographically

Consumer Loan Types  Auto/Boat/Other Asset – High Competition, Med Risk Can be securitized with high volume  Credit Cards – High Competition, Hi Risk day int grace on purch, immed int on cash advance……FEES!  Lines of Credit – Low Competition, Med Risk Revolving Lines with Check Writing

Other Consumer Lending  Mobile Homes  Balloon Loans  Leasing – High Competition, Low Risk Bank buys and “rents” to customer Open-end: Customer must buy (sell) at end of lease, Pay diff to residual value Closed-end: Bank takes asset back.

Consumer Loan Characteristics  Amortized Loan Pymt = $Loan / PVA (rate, term)  Balloon/Disc’d Loan Pymt = $Loan * FVF (rate, term) Pymt due only at term Disc’d Money Recv’d = Pymt * PVF  Annual Percentage Rate vs. Effective Annual Rate