Math 115a – Project 1Project 1 – Loan Work OutsSlide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Math 115a – Project 1Loan Work OutsProject 1 – Loan Work OutsBankPeople BusinessesDeposit extra cash in bankCommercial loanPersonal loanProject 1 – Loan Work OutsPersonalLoansCommercialLoansPaybackmonthly installmentsbegins 1 month after loan is taken outone lump sumpaid after a specified period of timeInterestpays monthly interest on the outstanding principalpays 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 OutsProject 1 – Loan Work OutsA borrower fails to make a regular payment.What can the bank do?Foreclose Work 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 acquireBanks 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 OutsAcadia Bank has an outstanding commercial loan to John Sanders’ entrepreneurial venturefull value of $4,000,000loan has 10% interest rateis one year oldscheduled to terminate in 4 yearsProject 1 – Loan Work OutsThe 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 OutsIf 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 OutsAcadia 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 OutsEach 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 OutsFor John Sanders’ case:he has 7 years of experience in this kind of businesshe has a Bachelor’s degree in Business Administrationthe economy is currently in “normal times”Project 1 – Loan Work OutsShould Acadia Bank enter into a work out agreement with Sanders, or should it foreclose on the loan?Project 1 – Loan Work OutsPreliminary Reports: With your team’s given data, present the following:Your team (introductions)Who your client isThe 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
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