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CHAPTER 12

CHAPTER 12. CONSUMER AND SMALL BUSINESS LENDING. LEARNING OBJECTIVES. TO UNDERSTAND…. The markets for and importance of small-business lending, consumer installment lending, residential mortgages, and home-equity lines of credit

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CHAPTER 12

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  1. CHAPTER 12 CONSUMER AND SMALL BUSINESS LENDING Chapter 12

  2. LEARNING OBJECTIVES TO UNDERSTAND… • The markets for and importance of small-business lending, consumer installment lending, residential mortgages, and home-equity lines of credit • The credit analysis, pricing, and risks of small-business, consumer, and residential-mortgage lending • Credit scoring for consumers and small businesses and how it can be misused • The importance and growth of subprime lending and the outcry about “predatory practices” and attempts to regulate them • The future of consumer and small-business lending Chapter 12

  3. Overview of Consumer Lending • At year-end 1985, commercial banks held total consumer loans of $284b, at the beginning of 2000, the figure was $558b (compound annual growth of 5%). • Credit-card loans grew from $68b year-end 1985 to $212b at the beginning of 2000 (compound annual growth of 8.5%). • Since year-end 1988, home-equity loans held by all commercial banks have grown from $35b to $98b at the beginning of 2000 (compound annual growth of 9.8%). Chapter 12

  4. The Role of TRICK • Transparency/disclosure/predatory practices have become major issues in subprime lending • Risk exposure of subprime lending has got the attention of the market and regulators • Information technology (credit scoring) plays a major in retail lending Chapter 12

  5. The Role of TRICK (continued) • Competition for customers has intensified especially for consumers and small businesses • Capital adequacy always is an issue in banking and has surfaced with respect to subprime lending Chapter 12

  6. Securitization • Started with government-sponsored enterprises (GSEs such as Ginnie Mae, Fannie Mae, and Freddie Mac) and the residential-mortgage market • Trickled down to credit cards and auto loans Chapter 12

  7. The Characteristics of Small Businesses • 500 employees of less => “small”, however, two-thirds of small businesses have fewer than five employees • Location: 80% in urban areas • SIC descriptionPercent Retail trade 21.7 Business services 21.2 Professional services 16.6 Construction/mining 14.2 All others 26.3 Chapter 12

  8. Financial Services Usedby Small Businesses • Three broad categories of services • Liquid-asset accounts • Checking and savings • Credit lines, loans, and capital leases • Financial-management services • Cash management, brokerage, trust, pension Chapter 12

  9. The Suppliers • Depository institutions • Table 12-3 (p. 397) shows that commercial banks dominate as suppliers of financial services to small businesses • Nondepository institutions • Finance company, brokerage, leasing • Nonfinancial • Family, individual, other businesses, government (SBA) Chapter 12

  10. Credit Analysis and Credit Scoring • Evolution from the 5Cs to credit scoring for consumers • Small businesses stand on the far left-hand side of the borrower-information continuum (Ch. 10) – scare information that is costly to obtain • Fewer than five employees => 5Cs approach might be best, especially character Chapter 12

  11. Credit Scoring: Understanding FICO (Box 12-1, p. 400) • Fair, Isaac & Co. is a risk-management company that have developed a credit-scoring system referred to as FICO. • A FICO score is based on information found within your credit report. The 5 basic categories of importance: • Payment History • Outstanding Debt • Credit History • Pursuit of New Credit • Types of Credit in Use Chapter 12

  12. Credit Scoring and Decision-Making • Figure 12-1 (p. 401) illustrates the trade-off at origination between credit score and the loan-to-value (LTV) ratio • Don’t short change the importance of human judgment Chapter 12

  13. Consumer Lending • Loan category2000 (growth)* Residential mortgages $ 839B (12.2%) Installment loans $ 346B ( 3.0%) Credit-card loans $ 212B (10.2%) Home-equity loans $ 98B (13.4%) Total $1,495B ( 9.8%) *Amount at the beginning of 2000 and growth rates since 1985 (1988 for home equity) Chapter 12

  14. Consumer Installment Credit: Market Share and Types of Loans • Types: Revolving (credit cards) and nonrevolving • Holders/Suppliers • Commercial banks • Finance companies • Credit unions • Savings institutions • Nonfinancial business (GE, GMAC) • Pools of securitized assets Chapter 12

  15. The Cost of Making Consumer Loans (functional cost analysis) • Cost categories • Office space • Supplies • Services • Labor • Tables 12-9, 12-10, 12-11 (pp. 408-410) present FCA data Chapter 12

  16. Credit Analysis ForConsumer Lending Five stages in the analysis of new customers: • Initial contact or introduction, • Credit application, • Review of the application, • Credit analysis or evaluation, and • Monitoring and control Chapter 12

  17. CAMPARI • An alternative to the five Cs of credit analysis is CAMPARI. In contrast to the five Cs, the CAMPARI framework is more specific with respect to the purpose and terms: • Character – the first of the five Cs • Ability – in managing financial affairs • Margin – interest rate, commission, and fees • Purpose – of the loan • Amount – of the loan • Repayment – probability of • Insurance – the collateral component of the five Cs Chapter 12

  18. A System Approach Versus Individual Appraisal • Credit-scoring systems have been in use for years • Examples of variables • Years on job • Home phone • Years at address • Major credit card • Credit bureau information Chapter 12

  19. Predicting Personal Bankruptcy • Research frameworks similar to those used in predicting corporate bankruptcy (classification models, Ch. 11) • Three national credit bureaus predict personal bankruptcies • Equifax • Trans Union • TRW Chapter 12

  20. Residential Real-Estate Lending: Mortgages and Home-Equity Lines of Credit • One of the biggest changes in bank consumer lending has resulted from the restructuring of the savings-and-loan industry. • At the end of 1985, all commercial banks held $188b in loans backed by one-to-four family residential property. In 1999, it was $767b or annual growth of 10.6%. Chapter 12

  21. Residential mtgs Bank sizeGrowth* Small 4.9% Medium 11.5% Large 14.4% Top ten 12.9% All banks 10.4% *1985-1999 Home-equity loans Bank sizeGrowth* Small -1.5% Medium -4.3% Large 6.8% Top ten 17.5% All banks 5.4% *1994-1999 Growth Chapter 12

  22. The Restructuring of Residential Lending • Fragmentation of the mortgage-lending process (securitization steps) • Origination • Funding/underwriting • Selling • Servicing • Investor Chapter 12

  23. Subprime Lending • Subprime portfolios are those made up of loans to borrowers with higher-risk characteristics defined to include: • A FICO score of 660 or lower • Two or more 30-day delinquencies in the past year • Bankruptcy in the last five years • A debt-to-income ratio of 50% or higher • A foreclosure, repossession, or charge-off in the preceding 24 months Chapter 12

  24. Myths AboutSubprime Lending • Myth #1: Subprime lending has been responsible for record homeownership rates among minorities and lower-income groups • Myth #2: By and large, subprime lending is priced efficiently • Myth #3: Proposed legislation is counterproductive Chapter 12

  25. The Future of Consumer and Small-Business Lending • Forces shaping the future • Regulation (Table 12-17, p. 423) • Interest-rate controls cause distortions (Figure 12-3, p. 422) • New sources of fee and choice • Automation and securitization Chapter 12

  26. Consumer Banking Innovations • Credit and debit cards • ATMs that permit cash advances (loans) • Systems approaches to lending • Home-equity loans • On-line banking Chapter 12

  27. CHAPTER SUMMARY • Consumer and small-business lending • Installment loans (credit cards) • Residential mortgages • Home-equity lines of credit • Loans and financial services for small businesses • Credit scoring and securitization • Subprime lending Chapter 12

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