LoansSlide 2Economic EnvironmentBusiness Cycle and Interest RatesCommercial LendingThe Business Dynamics of LoansDefinition of CollateralTypes of CollateralLending EvaluationMethods of PricingReal EstateReal Estate Loan CharacteristicsResidential RE Loan TermsCommercial Real EstateConsumer LendingConsumer Loan TypesOther Consumer LendingLoansLoansG&K, Chps. 9 & 10Economic EnvironmentCommercial and Industrial LendingReal Estate and Consumer LendingEconomic EnvironmentPattern of Interest Rates with unfolding Business Cycle.Predict Business Cycle (Trough, Growth, Boom, Peak, Slowdown, Recession, Trough……) Pattern of Interest Rates1-period ahead relatively easy (Simulation)Discussion here is expectation 2 + periods ahead…….Business Cycle and Interest RatesTrough: Low economic activity; low demand for funds, high demand for safe, liquid investments Low relative rates, + curveGrowth to Peak: Increasing economic activity; high demand for funds, low demand for interest-rate investments Higher relative rates, + to flattening curveSlowdownTrough; Slowing economic activity, early high demand for funds gives rise to drop off High rates drop, with inverted-curve returning to positive slopeCommercial LendingAsymmetric 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 borrowersMoral 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 LoansTrade-off between:Interest and fees gained, andCredit Risk of default and costsTypes:Lines of Credit, Term Loans, Bridge LoansTechnology has buffered:Securitization of loans: Mtgs, Cars, CCsCredit Scoring and Credit Risk transferDefinition of CollateralReduces Risk, but Increases MonitoringCharacteristics 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.Types of CollateralA/R – Pledging or FactoringInventorySecuritiesProperty or EquipmentLoan Guarantees – US Gov’t, StateLending EvaluationSix C’s:Character (personal traits)Capacity (cash flows)Capital (net worth)Collateral (pledged assets)Conditions (economic conditions)Compliance (Legal standing)Methods of PricingMarkup – BPs over index (prime)Cost of Funds – WACC + Profit GoalRelationship – Not just loan, but fees made elsewhere as an offsetMatch funding – BPs over match funds cost of moneyAdjustable rate – not just market yields, but also risk changesRequires extra monitoring and compliance review……Real EstateResidential, Commercial, Farm, Multi-familyOrigination, Securitization and ServicingBrokering, Securitization Resale and Real Estate Industry assistanceReal Estate Loan CharacteristicsDownpayment: 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 collateralizedResidential RE Loan TermsGuarantor:FHA, VA (as little as 3% down!)Rates:Fixed, 30 vs. 15, ARMsARMs: 3 and 1, 5 and 1, X and Y……Index, Caps, ResetsOther Terms:Buydowns, Assumables, Balloons, Points, Graduated Payments (GPMs), Growing Equity (GEMs), Shared ApprecCommercial Real EstateLand, construction and real estate development, and commercial properties Construction loans:Disbursements over time as project completedUsually of “Bridge” varietyLand serves as collateral for loans.Pricing Prime PlusOrigination as high as 3 PointsConsumer LendingPersonal LoansSmall Dollar, usually no collateralOpen Lines (CC) or Closed (Auto/Boat)Higher Risk Higher RateAttempt to diversify geographicallyConsumer Loan TypesAuto/Boat/Other Asset – High Competition, Med RiskCan be securitized with high volumeCredit Cards – High Competition, Hi Risk25-30 day int grace on purch, immed int on cash advance……FEES!Lines of Credit – Low Competition, Med RiskRevolving Lines with Check WritingOther Consumer LendingMobile HomesBalloon LoansLeasing – High Competition, Low RiskBank buys and “rents” to customerOpen-end: Customer must buy (sell) at end of lease, Pay diff to residual valueClosed-end: Bank takes asset
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