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  • 1. Lending Policies and Procedures
  • 2. The purpose of this chapter is to :• learn about lending policies• discuss problem loansTHE PRINCIPAL FUNCTION OF ABANK IS TO MAKE LOANS
  • 3. 16-3• Types of loans banks make• Factors affecting the mix of loans made• Regulation of lending• Creating a written loan policy• Steps in the lending process• Loan review and loan workouts
  • 4. Real estate loansFinancial institution loansAgriculture loansCommercial and industrial loansLoans to individualsMiscellaneous loansLease financing receivables
  • 5. 16-5
  • 6. Characteristics of market areaLender sizeExperience and expertise of managementExpected yield of each type of loanRegulations
  • 7. Capital adequacyAsset qualityManagement qualityEarnings recordLiquidity positionSensitivity to market risk
  • 8. Criticized LoansScheduled LoansAdversely Classified Loans • Substandard Loans • Doubtful Loans • Loss Loans
  • 9. Because the quality ofexamination information decaysvery quickly regulators arestarting to use market forces andprivate market discipline tomonitor bank behavior.
  • 10.  Goal statement for bank’s loan portfolio Specification of lending authority of each loan officer and committee Lines of responsibility in making assignments and reporting information Operating procedures for soliciting, evaluating and making loan decisions Required documentation for all loans Lines of authority for maintaining and reviewing credit files
  • 11.  Guidelines for taking and perfecting collateral Procedures for setting loan interest rate Statement of quality standards for all loans Statement of upper limit for total loans outstanding Description of the bank’s principal trade area Procedures for detecting, analyzing and working out problem loans
  • 12. 16-12 Why is lending so closely regulated by state and federal authorities? Whatis the CAMELS rating, and how is it used? List several elements of a good written loan policy.
  • 13.  Finding prospective loan customers Evaluating a customer’s character and sincerity of purpose Making site visits and evaluating a customer’s credit record Evaluating a customer’s financial record Assessing possible loan collateral and signing the loan agreement Monitoring compliance with the loan agreement and other customer service needs
  • 14. Character – specific purpose of loan and serious intent to repay loanCapacity – legal authority to sign binding contractCash – ability to generate enough cash to repay loan
  • 15. Collateral – adequate assets to support the loanConditions – economic conditions faced by borrowerControl – does loan meet written loan policy and how would loan be affected by changing laws and regulations
  • 16. Accounts ReceivablesFactoringInventoryRealPropertyPersonal PropertyPersonal Guarantees
  • 17. 15-18 Problem 16-3Crockett Manufacturing and Service Company holds asizable inventory of dryers and washing machineswhich it hopes to sell to retail dealers over the next sixmonths. These appliances have a total estimatedmarket value currently of $25 million. The firm alsoreports accounts receivable currently amounting to$12,650,000. Under the guidelines for taking collateraldiscussed in this chapter, what is the minimum size loanor credit line Crockett is likely to receive from itsprincipal lender? What is the maximum size loan orcredit line Crockett is likely to receive?
  • 18. 15-19Problem 16-3(continued)Crockett Manufacturing and Service Companyhas an appliance inventory currently valued at$25 million and accounts receivable of $12,650,000. The text says that inventory loanscommonly amount to 30 percent to 80 percentof the inventorys estimated market value andaccount-receivable based loans commonlyamount to 40 to 90 percent of estimatedmarket value.
  • 19. 15-20 Problem 16-3(continued)These figures suggest that the minimum size credit line available would be: 0.30 x $25,000,000 + 0. 40 x $12,650,000 = $7,500,000 + $5,060,000= $12,560,000.The maximum sized credit line available would be: 0.80 x $25,000,000 + 0.90 x $ 12,650,000 = $20,000,000+ 11,385,000 = $31,385,000
  • 20. Spreadsheet AnalysisRatios Current ratio Inventory turnover ratio Quick ratio Leverage ratioCommon-size income statement and balance sheetSources of industry information RMA COMPARE2 Dun & Bradstreet Moody’s S&P
  • 21. Consumer-supplied financial statementsCredit bureau reportsExperience of other lendersVerification of employmentVerification of property ownershipThe web
  • 22.  Financial reports supplied by the borrowing firm Copies of board of director’s resolutions or partnership agreements Credit ratings – Dun & Bradstreet, Moody’s, Standard & Poor’s New York Times, Wall Street Journal, other business publications Risk Management Associates, Dun & Bradstreet industry averages Web
  • 23. Government Budget reportsCreditRatings assigned to government borrowers by Moody’s, Standard & Poor’s, FitchWeb
  • 24. The Promissory NoteLoan Commitment AgreementCollateralCovenants • Affirmative • NegativeBorrower Guaranties and WarrantiesEvents of Default
  • 25. Examination of outstandingloans to make sure borrowersare adhering to their creditagreements and the bank isfollowing its own loanpolicies
  • 26.  Carrying out review of all types of loans on a periodic basis Structuring the loan process • Record of borrower payments • Quality and condition of collateral • Completeness of loan documentation • Evaluation of borrower’s financial condition • Assessment as to whether fits with lender’s loan policies
  • 27. Reviewing largest loans most frequentlyConducting more frequent reviews of troubled loansAccelerating the loan review schedule if economy or industry experiences problems
  • 28.  Unusual or unexpected delays in receiving financial statements Any sudden changes in accounting methods Restructuring debt or eliminating dividend payments or changes in credit rating Adverse changes in the price of stock Losses in one or more years Adverse changes in capital structure Deviations in actual sales from predictions Unexpected and unexplained changes in deposits
  • 29. The process of resolving atroubled loan so the bank canrecover its funds
  • 30.  Goal is to maximize full recovery of funds Rapid detection and reporting of problems is essential Loan workout should be separate from lending function Should consult with customer quickly on possible options Estimate resources available to collect on loan Conduct tax and litigation search Evaluate quality and competence of management Consider all reasonable alternatives
  • 31. 16-32• What three major questions or issues must a lender consider in evaluating nearly all loan requests?• Explain the following terms: character, capacity, cash, collateral, conditions, and control.
  • 32. 16-33 Quick Quiz • What are the principal parts of a loan agreement? What is each part designed to do? • What are some warning signs to management that a problem loan may be developing?McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.Bank Management and Financial Services, 6/e
  • 33.  Making loans is principal economic function of banks Lending is risky Written loan policy CAMELS and Six C’s of credit Credit analysis • Normalize income statement and balance sheet • Credit worthiness of borrower • Structure of loan agreement • Perfect of claim on borrower Loan review process Problem loan workout
  • 34. 15-35 Problem 16-2Aspiration Corporation, seeking renewal of its$12 million credit line, reports the data in thefollowing table (in millions of dollar) to HotSprings National Bank’s loan department.Please calculate the firm’s cash flow as definedearlier in this chapter. What trends do youobserve and what are their implications for thedecision to renew or not renew the firm’s creditline?
  • 35. 15-36 Problem 16-2 (continued) Proj. for 20X1 20X2 20X3 20X4 Next YrSales Revenue 7.9 8.4 8.8 9.5 9.9Costs of Goods Sold $5.1 $5.5 $5.7 $6.0 $6.4Selling and Admin Exp. 8.0 8.2 8.3 8.6 8.9Depreciation and other noncash expenses 11.2 11.2 11.1 11.0 10.9Taxes Paid in Cash 4.4 4.6 4.9 4.1 3.6
  • 36. 15-37 Problem 16-2 (continued) Cash Flow = Sales Revenues – Cost of Goods Sold – Selling and Admin – Taxes Paid in Cash + Non Cash Expenses 20x1 $7.9 - $5.1 - $8.0 - $4.4 + $11.2 = $1.6 million 20x2 $8.4 - $5.5 - $8.2 – $4.6 + $11.2 = $1.3 million 20x3 $8.8 - $5.7 - $8.3 - $4.9 + $11.1 = $1.0 million 20x4 $9.5 - $6.0 - $8.6 - $4.1 + $11.0 = $1.8 million Next $9.9 - $6.4 - $8.9 - $3.6 + $10.9 = $1.9 million Year Proj. for 20X1 20X2 20X3 20X4 Next Yr Cash Flow Estimate $1.6 $1.3 $1.0 $1.8 $1.9
  • 37. 15-38 Problem 16-2 (continued)While this firm had an initial decrease in cashflows, in the last year its cash flows haverebounded significantly, suggesting that the firmwould have less trouble making required loanpayments. The lender needs to be sure to check tosee if the projections for next year seemreasonable. Borrowers are sometimes overoptimistic about future opportunities. However, ifthe projections are reasonable, Hot SpringsNational Bank should consider renewing the loan.

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