Math 115a – Project 1 Loan Work Outs

Project 1 – Loan Work Outs Bank PeopleBusinesses Deposit extra cash in bank Commercial loan Personal loan

Project 1 – Loan Work Outs Personal Loans Commercial Loans Payback  monthly installments  begins 1 month after loan is taken out  one lump sum  paid after a specified period of time Interest  pays monthly interest on the outstanding principal  pays interest monthly We will only consider commercial loans.

 Who should the bank lend to?  What qualities does a bank look for in a borrower? Project 1 – Loan Work Outs

A borrower fails to make a regular payment. What can the bank do? ForecloseWork Out Bank can salvage some of the loan without doubt (bank takes ownership of an asset (collateral for the loan) and sells it on the market) Bank loses money Typically forces borrower into bankruptcy Loses a client-relationship Bank can recover the entire loan amount Retains working relationship with client Risky business: if borrower still cannot repay loan, then there are generally less assets to acquire

 Banks must consider: why did the borrower miss a payment?  temporary lack of funds?  more permanent problem? what is the long-run viability of the borrower? To protect itself against litigation, a bank must base the decision about whether or not to attempt a work out arrangement on quantifiable considerations. Project 1 – Loan Work Outs

 Acadia Bank has an outstanding commercial loan to John Sanders’ entrepreneurial venture full value of $4,000,000 loan has 10% interest rate is one year old scheduled to terminate in 4 years Project 1 – Loan Work Outs

 The last interest payment was due three weeks ago.  The bank audited John’s books, and discovered that the venture is illiquid, and will be unable to make interest payments for at least the next three months.  What should Acadia do? Project 1 – Loan Work Outs

 If Acadia forecloses on Sanders’ loan: it will recover a foreclosure value of $2,100,000 on the $4,000,000 loan. if it attempts a work out, and Sanders’ venture fails anyway, the business will have decreased in value, and the bank will recover a default value of $250,000 on the loan. Project 1 – Loan Work Outs

 Acadia Bank is the result of a merger of three banks: BR Bank has work out records which include number of years of entrepreneur’s experience. Cajun Bank has work out records which include the entrepreneur’s education level (high school, bachelor’s degree, or graduate) DuPont Bank has work out records which include the state of the economy (recession, normal, or boom) Project 1 – Loan Work Outs Each of the former banks made loans to very similar populations of borrowers.

 Years of experience of a borrower, educational level of a borrower, and current economic conditions are all independent of one another.  Moreover, these factors are independent, even if only successful loan work outs or only failed work out attempts are considered. Project 1 – Loan Work Outs

 For John Sanders’ case: he has 7 years of experience in this kind of business he has a Bachelor’s degree in Business Administration the economy is currently in “normal times” Project 1 – Loan Work Outs

Should Acadia Bank enter into a work out agreement with Sanders, or should it foreclose on the loan? Project 1 – Loan Work Outs

 Preliminary Reports: With your team’s given data, present the following: Your team (introductions) Who your client is The actual data (full value, default value, etc.) What the loan is for (here is your chance to be tastefully creative) A preliminary decision: foreclose or work out? Project 1 – Loan Work Outs