04 Lending - Overview

8/12/2019 04 Lending - Overview

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Contents

Types of Loans

Factors Affecting the Mix of Loans Made

Credit analysis

Steps in the Lending Process

Loan Review and Loan Workouts

Optional readings

Regulation of Lending

Creating a Written Loan Policy

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Introduction

Banks main job is to make loans

Loans support the growth of new businesses and jobs withinthe lenders market area

Loans frequently convey information to the marketplaceabout a borrowers credit quality

The lending process should be carefully monitored

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Types of Loans

Real Estate Loans (including mortgage)

Financial Institution Loans

Agriculture Loans

Commercial and Industrial Loans

Loans to Individuals

Miscellaneous Loans

Lease Financing Receivables

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E.g: ACB


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Types of Loans (continued)

Factors Determining the Growth and Mix of Loans

Characteristics of the market area

Lender size

Wholesale lenders vs. retail credit Experience and expertise of management

Loan policy

Expected yield of each type of loan

Regulation

General rule: A lending institution should make the types ofloans for which it is the most efficient producer

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Regulation of Lending

The mix, quality, and yield of the loan portfolio are heavilyinfluenced by regulation

Examples of lending regulations:

Total loan to a single customer normally cannot exceed 15percent of a singlebanks equity (legal lending limit)

Any loans made are subject to examination and review

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Regulation of Lending (continued)

Uniform Financial Institutions Rating System

Each banking firm is assigned a numerical rating based on thequality 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

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Asset Quality

Criticized loans: good but not in full compliance with thebanks loan policy

Scheduled loans: significant weaknesses (creditconcentration in a borrower or an industry)

Adversely classified loans

Substandard loans: problems with repayment abilities &collateral

Doubtful loans: high probability of uncollectible loss

Loss loans: uncollectible

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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

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Establishing a Good Written Loan Policy

Important in order to meet regulatory standards

What should a written loan policy contain?

A goal statement for the entire loan portfolio

Specification of lending authority of each loan officer andloan committee

Lines of responsibility in making assignments andreporting information

Operating procedures for soliciting, evaluating andmaking loan decisions

Required documentation for all loans

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Establishing a Good Written Loan Policy (cont)

Lines of authority for maintaining and reviewing credit files

Guidelines for taking, evaluating, and perfecting loan

collateral. Procedures for setting loan rates and fees and the terms for

repayment of loans

A statement of quality standards applicable to all loans

A statement of the preferred upper limit for total loansoutstanding

A description of the lending institutions principal trade area

Procedures for detecting and working out problem loansituations.

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Steps in lending process6 steps

1. Find prospective customers

Individuals: normally come to the bank

Business loans: through salespeople contacts

2. Evaluate customers character and sincerity ofpurpose

Interview: customer explains his credit needs

Loan officer to assess customers sincerity

3. Make site visit & evaluate credit records of customer Location and condition of property

Records of customers previous loans


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Steps in lending process

4. Evaluate customers financial condition

Does customer have sufficient cash flow and backup assets torepay the loan?

5. Assess collateral & sign the loan agreement6. Monitor customers compliance with the agreement

Ensure terms are being followed, principal and interest arepaid in time

Visit customers & explore new opportunities


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Credit analysis Is the borrower creditworthy?

How to structure the loan so that lender is protected andborrower is able to repay

Can lender secure its claim on the collateral in the event of

loan default

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Credit Analysis: What Makes a Good Loan?

1. Is the Borrower Creditworthy? The Cs of Credit

Character Specific purpose of loan and serious intent to repay the loan

Capacity

Legal authority to sign binding contract Cash

Ability to generate enough cash to repay loan

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

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Credit Analysis: What Makes a Good Loan?(continued)

2. Can the Loan Agreement Be Properly Structuredand Documented?

Draft a loan agreement that meets the borrowers need forfunds with a comfortable repayment schedule

Proper accommodation of a customer may involve lendingmore or less money than requested over a longer or shorter

period

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Credit Analysis: What Makes a Good Loan?(continued)

3. Can lender secure its claim on the collateral in the event ofloan default?

Reasons for Taking Collateral

If the borrower cannot pay, the pledge of collateral gives the lender

the right to seize and sell those assets It gives the lender a psychological advantage over the borrower

Types of Collateral

Accounts Receivables

Factoring

Inventory

Real Property

Personal Property

Personal Guarantees

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EXHIBIT 161 Safety Zones Surrounding Funds Loaned inOrder to Protect a Lender

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TABLE 164 Sources of Information Frequently Used in LoanAnalysis and Evaluation by Lenders and Loan Committees

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Parts of a Typical Loan Agreement

The Note: principal, interest, terms of repayment

Collateral

Covenants

Affirmative Negative

Borrower Guaranties

Events of Default

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Loan Review

1. Carrying out reviews of all types of loans on a periodic basis

2. Structuring the loan review process: check

Record of borrower payments

Quality and condition of collateral

Completeness of loan documentation

Evaluation of borrowers financial condition

Assessment as to whether the loan fits with the lenders loan policies

3. Reviewing Largest Loans Most Frequently

4. Conducting More Frequent Reviews of Troubled Loans

5. Accelerating the Loan Review Schedule if Economy or IndustryExperiences Problems

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Loan Workouts

Loan workoutthe process of recovering funds from a problem

loan situation

Warning Signs of Problem Loans

1. Unusual or unexpected delays in receiving financial statements2. Any sudden changes in accounting methods

3. Restructuring debt or eliminating dividend payments or changes incredit rating

4. Adverse changes in the price of stock

5. Losses in one or more years6. Adverse changes in capital structure

7. Deviations in actual sales from projections

8. Unexpected or unexplained changes in deposits

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Loan Workouts (continued)

What steps should a lender take when a loan is in trouble?

1. Do not forget the goal: Maximize full recovery of funds

2. Rapid detection and reporting of problems is essential

3. Loan workout should be separate from lending function

4. Should consult with customer quickly regarding possible options

5. Estimate resources available to collect on loan

6. Conduct tax and litigation search

7. Evaluate quality and competence of management

8. Consider all reasonable alternatives

Preferred option: Seek a revised loan agreement

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Documents

04 Lending - Overview