The document discusses lending policies and procedures at banks. It covers types of loans banks make, factors that affect loan mix, regulation of lending, creating a written loan policy, the lending process, and reviewing and working out problem loans. Key points include the need for written lending policies, regulatory oversight of lending, and processes for evaluating loans, identifying problems, and resolving troubled loans.

1. Lending Policies and Procedures

2. The purpose of this chapter is to :
• learn about lending policies
• discuss problem loans
THE PRINCIPAL FUNCTION OF A
BANK 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 of
examination information decays
very quickly regulators are
starting to use market forces and
private market discipline to
monitor 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

15. 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

16. 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

17. Accounts Receivables
Factoring
Inventory
RealProperty
Personal Property
Personal Guarantees

18. 15-18
Problem 16-3
Crockett Manufacturing and Service Company holds a
sizable inventory of dryers and washing machines
which it hopes to sell to retail dealers over the next six
months. These appliances have a total estimated
market value currently of $25 million. The firm also
reports accounts receivable currently amounting to
$12,650,000. Under the guidelines for taking collateral
discussed in this chapter, what is the minimum size loan
or credit line Crockett is likely to receive from its
principal lender? What is the maximum size loan or
credit line Crockett is likely to receive?

19. 15-19
Problem 16-3(continued)
Crockett Manufacturing and Service Company
has an appliance inventory currently valued at
$25 million and accounts receivable of $
12,650,000. The text says that inventory loans
commonly amount to 30 percent to 80 percent
of the inventory's estimated market value and
account-receivable based loans commonly
amount to 40 to 90 percent of estimated
market value.

20. 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

21. 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

22. Consumer-supplied financial
statements
Credit bureau reports
Experience of other lenders
Verification of employment
Verification of property ownership
The web

23.  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

24. Government Budget reports
CreditRatings assigned to
government borrowers by
Moody’s, Standard & Poor’s, Fitch
Web

25. The Promissory Note
Loan Commitment Agreement
Collateral
Covenants
• Affirmative
• Negative
Borrower Guaranties and Warranties
Events of Default

26. Examination of outstanding
loans to make sure borrowers
are adhering to their credit
agreements and the bank is
following its own loan
policies

27.  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

28. Reviewing largest loans most
frequently
Conducting more frequent reviews
of troubled loans
Accelerating the loan review
schedule if economy or industry
experiences problems

29.  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

30. The process of resolving a
troubled loan so the bank can
recover its funds

31.  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

32. 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.

33. 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

34.  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

35. 15-35
Problem 16-2
Aspiration Corporation, seeking renewal of its
$12 million credit line, reports the data in the
following table (in millions of dollar) to Hot
Springs National Bank’s loan department.
Please calculate the firm’s cash flow as defined
earlier in this chapter. What trends do you
observe and what are their implications for the
decision to renew or not renew the firm’s credit
line?

36. 15-36
Problem 16-2 (continued)
Proj. for
20X1 20X2 20X3 20X4 Next
Yr
Sales Revenue 7.9 8.4 8.8 9.5 9.9
Costs of Goods Sold $5.1 $5.5 $5.7 $6.0 $6.4
Selling and Admin Exp. 8.0 8.2 8.3 8.6 8.9
Depreciation and other
noncash expenses 11.2 11.2 11.1 11.0 10.9
Taxes Paid in Cash 4.4 4.6 4.9 4.1 3.6

37. 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

38. 15-38
Problem 16-2 (continued)
While this firm had an initial decrease in cash
flows, in the last year its cash flows have
rebounded significantly, suggesting that the firm
would have less trouble making required loan
payments. The lender needs to be sure to check to
see if the projections for next year seem
reasonable. Borrowers are sometimes over
optimistic about future opportunities. However, if
the projections are reasonable, Hot Springs
National Bank should consider renewing the loan.