FIN4324 Study Guide 1 Types of Commercial Bank Loans Real Estate Loans Agriculture Loans Financial Institution Loans Commercial and Industrial Loans include credit to banks insurance companies are extended to farms and ranches to assist in planting secured by real property land buildings and other structures finance companies and other financial institutions and harvesting crops and supporting the feeding and care of livestock are granted to businesses to cover purchasing inventories paying taxes and meeting payrolls mobile homes appliances and other retail goods loans and leases them to its customers include credit to finance the purchase of automobiles include all loans not listed above including securities where the lender buys equipment or vehicles Lease Financing Receivables Miscellaneous Loans Loans to Individuals The largest category in dollar volume is real estate loans followed by loans to individuals and commercial and industrial C I loans 2 Bank Regulators Loan Criteria for Bank Lending institutions are among the most closely regulated of all financial service institutions The mix quality and yield of the loan portfolio are heavily influenced by regulation any loans made are subject to examination and review and many are restricted or even prohibited by law Examples of lending regulations The total volume of real estate loans granted by a U S national bank cannot exceed that bank s capital and surplus or 70 percent of its total time and savings deposits whichever is greater An unsecured loan to a single customer normally cannot exceed 15 percent of a single national bank s unimpaired capital and surplus account legal lending limit The Community Reinvestment Act of 1977 Selected lenders to must make an affirmative effort to meet the credit needs of individuals and businesses in their trade territories so that no areas of the local community are discriminated against in seeking access to credit The Equal Credit Opportunity Act of 1974 No individual can be denied credit because of race sex religious affiliation age or receipt of public assistance The International Lending and Supervision Act Requires U S banks to make public any credit exposures to a single country that exceed 15 percent of their primary capital or 0 75 percent of their total assets whichever is smaller This law also imposes restrictions on the fees lenders may charge a troubled international borrower to restructure a loan Uniform Financial Institutions Rating System Each banking firm is assigned a numerical rating based on the quality of its asset portfolio The federal examiner may assign one of these ratings 1 strong performance 2 satisfactory performance 3 fair performance 4 marginal performance 5 unsatisfactory performance Asset Quality o Criticized loans Loans that are performing well but have minor weaknesses because the lender has not followed its own loan policy or has failed to get full documentation from the borrower o Scheduled loans Loans that appear to contain significant weaknesses or that represent what the examiner regards as a dangerous concentration of credit in one borrower or in one industry o Adversely classified loans o Doubtful loans o Substandard loans where the loans margin of protection is inadequate due to weaknesses in collateral or in the borrower s repayment abilities to the lending institution bankable assets regarded as uncollectible and not suitable to be called carry a strong probability of an uncollectible loss o Loss loans 3 Camels CAMELS Rating Capital adequacy Asset quality Management quality Earnings record Liquidity position Sensitivity to market risk exposure All six dimensions of performance are combined into one overall numerical rating referred to as the CAMELS rating Depository institutions whose overall rating is low tend to be examined more frequently than the highest rated institutions o Specific purpose of loan and serious intent to repay the loan 4 6 C s Is the Borrower Creditworthy The Cs of Credit Character Capacity Cash Collateral Conditions Control o Legal authority to sign binding contract o Ability to generate enough cash to repay loan o Adequate assets to support the loan o Economic conditions faced by borrower o Does loan meet written loan policy and how would loan be affected by changing laws and regulations All of the Cs of credit must be satisfactory for the loan to be a good one from the lender s point of view 5 Elements To a Loan Agreement The Promissory Note signed by the borrower specifies the principal amount of the loan Loan Commitment Agreement lender promises to make credit available to the borrower over a designated future period up to a maximum amount in return for a commitment fee Collateral Covenants Affirmative Negative Borrower Guaranties or Warranties Events of Default 6 Types of Short Term Business Loans Self Liquidating Inventory Loans These loans usually were used to finance the purchase of inventory raw materials or finished goods to sell Such loans take advantage of the normal cash cycle inside a business firm There appears to be less of a need for traditional inventory financing Due to the development of just in time JIT and supply chain management techniques Working Capital Loans Short run credit that lasts from a few days to one year Secured by accounts receivable or by pledges of inventory Carry a floating interest rate A commitment fee is charged on the unused portion of the credit line and sometimes on the entire amount of funds made available Compensating deposit balances may be required from the customer Recently compensating deposit balances as a part of a business loan arrangement has been on the decline Interim Construction Financing Secured short term loan used to support the construction of homes apartments office buildings shopping centers and other permanent structures Security Dealer Financing Dealers in securities need short term financing to purchase new securities and carry their existing portfolios of securities until they are sold to customers or reach maturity Retailer and Equipment Financing Lenders support installment purchases of automobiles home appliances and other durable goods by financing the receivables that dealers selling these goods take on when they write installment contracts to cover customer purchases Asset Based Financing Credit secured by the shorter term assets of a firm that are expected to roll over into cash in the future Syndicated Loans SNCs A loan package extended to a