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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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Loans2 l.jpg
Loans

  • G&K, Chps. 9 & 10

  • Economic Environment

  • Commercial and Industrial Lending

  • Real Estate and Consumer Lending


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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…….


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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


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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!


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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


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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.


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Types of Collateral

  • A/R – Pledging or Factoring

  • Inventory

  • Securities

  • Property or Equipment

  • Loan Guarantees – US Gov’t, State


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Lending Evaluation

  • Six C’s:

    • Character (personal traits)

    • Capacity (cash flows)

    • Capital (net worth)

    • Collateral (pledged assets)

    • Conditions (economic conditions)

    • Compliance (Legal standing)


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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……


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Real Estate

  • Residential, Commercial, Farm, Multi-family

  • Origination, Securitization and Servicing

  • Brokering, Securitization Resale and Real Estate Industry assistance


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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


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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


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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


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Consumer Lending

  • Personal Loans

  • Small Dollar, usually no collateral

  • Open Lines (CC) or Closed (Auto/Boat)

  • Higher Risk  Higher Rate

  • Attempt to diversify geographically


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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


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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.


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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