Because the quality ofexamination information decaysvery quickly regulators arestarting to use market forces andprivate market discipline tomonitor bank behavior.
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
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
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.
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
Character – specific purpose of loan and serious intent to repay loanCapacity – legal authority to sign binding contractCash – ability to generate enough cash to repay loan
Collateral – adequate assets to support the loanConditions – economic conditions faced by borrowerControl – does loan meet written loan policy and how would loan be affected by changing laws and regulations
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?
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.
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
Spreadsheet AnalysisRatios Current ratio Inventory turnover ratio Quick ratio Leverage ratioCommon-size income statement and balance sheetSources of industry information RMA COMPARE2 Dun & Bradstreet Moody’s S&P
Consumer-supplied financial statementsCredit bureau reportsExperience of other lendersVerification of employmentVerification of property ownershipThe web
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
Government Budget reportsCreditRatings assigned to government borrowers by Moody’s, Standard & Poor’s, FitchWeb
The Promissory NoteLoan Commitment AgreementCollateralCovenants • Affirmative • NegativeBorrower Guaranties and WarrantiesEvents of Default
Examination of outstandingloans to make sure borrowersare adhering to their creditagreements and the bank isfollowing its own loanpolicies
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
Reviewing largest loans most frequentlyConducting more frequent reviews of troubled loansAccelerating the loan review schedule if economy or industry experiences problems
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
The process of resolving atroubled loan so the bank canrecover its funds
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
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.
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
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?
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
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
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.