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Loans

Loans. 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.

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Loans

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  1. Loans

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

  3. 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…….

  4. 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

  5. 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!

  6. 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

  7. 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.

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

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

  10. 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……

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

  12. 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

  13. 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

  14. 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

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

  16. Consumer Loan Types • Auto/Boat/Other Asset – High Competition, Med Risk • Can be securitized with high volume • Credit Cards – High Competition, Hi Risk • 25-30 day int grace on purch, immed int on cash advance……FEES! • Lines of Credit – Low Competition, Med Risk • Revolving Lines with Check Writing

  17. 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.

  18. 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

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