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LESSON 13 ( Additional Material)

LESSON 13 ( Additional Material)

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LESSON 13 ( Additional Material)

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  1. LESSON 13(Additional Material) Lending Policies and Procedures: Managing Credit Risk

  2. Key Topics • Types of Loans Banks and Competing Lenders 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

  3. Introduction • The main reason many banks are issued charters of incorporation by state and national governments is to make loans • Lenders are expected to supply credit for all legitimate business and consumer financial needs and to price that credit fairly

  4. Introduction • Loans support the growth of new businesses and jobs within the lender’s market area • Loans frequently give information to the marketplace about a borrower’s credit quality • The lending process requires careful monitoring at all times

  5. Types of Loans • Real Estate Loans – For personal homes • Loans to individuals – for cars, personal needs • Commercial and Industrial Loans – business start-ups, growing a business • Agriculture Loans – for farmers • Miscellaneous Loans • Lease Financing Receivables • The largest category in dollar volume is real estate loans, followed by loans to individuals, and commercial and industrial (C&I) loans

  6. TABLE 16–1 Loans Outstanding for All FDIC-Insured Banks as of December 31, 2010 (consolidated domestic and foreign offices)

  7. 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 of loans for which it is the most efficient or best producer

  8. Regulation of Lending (continued) • The Community Reinvestment Act of 1977 • Lenders must make every effort to meet the credit needs of individuals and businesses in their area so that no areas of the local community are discriminated against in seeking credit (a loan) • The Equal Credit Opportunity Act of 1974 • No individual can be denied credit because of race, sex, religious affiliation, age, or receipt of public assistance

  9. Regulation of Lending (continued) • Uniform Financial Institutions Rating System • Each banking firm is assigned a numerical rating based on the quality 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

  10. Regulation of Lending (continued) • CAMELS Rating • Capital (is there enough to support the loans) • 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

  11. Regulation of Lending (continued) • Establishing a Good Written Loan Policy • Important in order to meet regulatory standards • What should a written loan policy contain? 1. Purpose of the loan 2. The lending authority of each loan officer and loan committee

  12. Regulation of Lending (continued) • What should a written loan policy contain? 3. Lines of responsibility reporting information 4. Operating procedures for selling, evaluating and making loan decisions 5. Required documentation for all loans

  13. Regulation of Lending (continued) • Added guidelines for making a Good Written Loan Policy • Who will maintain and review credit files • Guidelines for taking and evaluating loan collateral. • Setting loan rates and fees and the terms for repayment of loans • Procedures for working out problem loan situations.

  14. Steps in the Lending Process • Finding Loan Customers • Evaluating a Customer’s Character and Purpose • Evaluating a Customer’s Credit Record • Evaluating a Customer’s Financial Condition • Assessing Possible Loan Collateral and Signing the Loan Agreement • Monitoring Compliance with the Loan Agreement and Other Customer Service Needs

  15. Credit Analysis: What Makes a Good Loan? • Is the Borrower Creditworthy? The Cs of Credit (Adverse Selection Process) • Character • Purpose of loan and intent to repay the loan (Moral Hazard) • Capacity • Legal authority to sign binding contract • Cash • Ability to generate enough cash to repay loan (Moral Hazard). Income, savings

  16. Credit Analysis: What Makes a Good Loan? • Is the Borrower Creditworthy? The Cs of Credit • Collateral • Enough 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. Credit Analysis: What Makes a Good Loan? (continued) • Can the Loan Agreement Be Properly Structured and Documented? • Aloan agreement that meets the borrower’s need for funds with a comfortable repayment schedule • Proper understanding of a customer may involve lending more or less money than requested over a longer or shorter period

  18. Credit Analysis: What Makes a Good Loan? (continued) • Does the customer have Collateral? • 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 – money coming in • Inventory – equipment (machinery, vehicles) • Real Property • Personal Property • Personal Guarantees

  19. Parts of a Typical Loan Agreement • The Promissory Note – the amount, the interest rate and terms of the loan • Loan Commitment Agreement – document that says loan is made for a certain time for a maximum amount in return for a fee. • Collateral – pledged assets to cover loan

  20. Parts of a Typical Loan Agreement • Covenants – What the borrower must and must not do. • Affirmative – borrower must do • Negative – borrower must not do • Events of Default – What the borrower can legally do in case the loan goes bad

  21. Loan Review • Carrying out reviews of all types of loans on a periodic basis • Structuring the loan review process • Record of borrower payments • Quality and condition of collateral • Completeness of loan documentation • Evaluation of borrower’s financial condition

  22. Loan Review • Reviewing Largest Loans Most Frequently • Conducting Reviews of Troubled Loans Often • Changing the Loan Review Schedule if Economy or Industry Experiences Problems

  23. Loan Workouts • Loan workout – the process of recovering funds from a problem loan situation • Warning Signs of Problem Loans • Delays in receiving payments • Changes in credit rating • Losses in one or more years • Changes in collateral • Decline in actual sales • Decline in deposits

  24. Loan Workouts (continued) • What steps should a lender take when a loan is in trouble? • Do not forget the goal: Get all the funds paid back • Rapid detection and reporting of problems • Loan workout should be separate from lending

  25. Loan Workouts (continued) • What steps should a lender take when a loan is in trouble? • Should consult with customer regarding options to pay • What are resources to collect on loan? • Evaluate the quality of management • Consider all alternatives and options • Preferred option: Seek a new loan agreement

  26. Quick Quiz • In what ways do loans affect the economy of its community or region? Slides 4 and 8 2. What are the types of loans made by banks? Slides 5 and 6 3. Why is lending so closely regulated by state and federal authorities? Slides 8-13 4. What should a good written loan policy contain? Slides 12 and 13

  27. Quick Quiz • What three major questions must a lender consider in evaluating nearly all loan requests? Slides 15-18 • Explain the following terms: character, capacity, cash, collateral, conditions, and control. Slides 15 and 16

  28. Quick Quiz • What are the principal parts of a loan agreement? What is each part designed to do? Slides 19 and 20 • What is loan review? How should a loan review be conducted? Slides 21 and 22 • What steps should a lender go through in trying to resolve a problem loan situation? slides 23-25