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   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
   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
       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
   Technology has buffered:
       Securitization of loans: Mtgs, Cars, CCs
       Credit Scoring and Credit Risk transfer
Definition of Collateral
   Reduces Risk, but Increases
   Characteristics of good collateral:
       Durability is the ability of the asset to
        withstand wear. Durable versus nondurable
       Identification due to physical uniqueness
        or serial numbers.
       Marketability of the property if resold.
       Stability of value over the period of the
       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,
   Origination, Securitization and
   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
   Construction loans:
       Disbursements over time as project
       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
       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
Other Consumer Lending
   Mobile Homes
   Balloon Loans
   Leasing – High Competition, Low
       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

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