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Decision-Making for Loans: Workout vs. Foreclosure in Banking

DESCRIPTION

This project addresses the critical decision banks face when borrowers default on loans, analyzing whether to enter a workout agreement or proceed with foreclosure. The case of John Sanders, a borrower with over $4 million at risk, showcases the importance of evaluating expected outcomes. By employing mathematical tools such as probability and expected values, we will explore Acadia Bank's options, leveraging historical data to guide decisions in similar scenarios. This analysis aims to balance profitability with the ethical considerations of borrower support.

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Decision-Making for Loans: Workout vs. Foreclosure in Banking

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Presentation Transcript

  1. Project Description • Business Background • Class Project

  2. Business Background • Loans Personal- Borrower receives money & pays back monthly Commercial- Borrower keeps the entire money (for a fixed period) Returns the Principal as a lump sum Regularly pays the interest • We will be considering Commercial loans

  3. Business Background-contd. • Most Important problem for Banks- Deciding to whom they should lend • Decisions- Processing information (Business plan/ Data about past loan workouts) • Lends money if the Probability of repaying loan is sufficiently high • If the borrower fails to make expected interest ( Default on the loan) • Bank has two options ( Objective-Profitability) - Foreclose loan - Loan Workout

  4. Business Background-contd. • Bank Forecloses a loan if Benefits of Foreclosure > Benefits of Workout • What is Foreclosure? Bank requires the borrower to pay back Principal+ Interest or Bank takes over ownership of the relevant assets & sells it (may put the borrower out of business)

  5. Business Background-contd. • Bank enters a Loan Workout if Expected Value Workout > Expected Value Foreclose • What is Loan Workout? Attempt to salvage the loan by setting up a new schedule or temporarily deferring such payments

  6. Class Project • John Sanders ( has failed to pay interest) • 7 years Experience • Bachelor’s Degree • Economic Condition- Normal • Full Value- $ 4,000,000 (Loan value) • Default Value- $ 250,000 (loan workout fails ) • Foreclosure Value- $ 2,100,000 (If bank Foreclose )

  7. Class Project • Acadia Bank (Merger of BR Bank/ Cajun Bank/ Dupont Bank) • Historical Data on Loan Workouts ( Assume similar Clients) • BR - Experience • Cajun- Education Status • Dupont- State of Economy

  8. Class Project • Using the Mathematical Tools (Eg: Basic Probability/Expected Values/ Conditional Probability…) • Need to create a Business Solution • Should Acadia Bank enter into a workout agreement with John, or should it foreclose on the loan?

  9. Project 1-assumptions • Similar clients-Each of the three former banks made loans to very similar populations of borrowers • Experience/Education Status/State of Economy are all independent of each other

  10. Preliminary Report • Preliminary Report – TBN • Teams & Data for Project 1 on Class website • 3-5 minutes PowerPoint presentation • You will be asked 1-2 questions about the presentation • You need to give me a copy of the PPT presentation (size 6X4) • Dress Code- Business Casual

  11. Preliminary Report-contd. • Read about report on MBD part1.ppt(Slide # 32) • Should start the presentation by introducing the team • A Discussion of the problem • Definitions • Project Assumptions • Study of Historical Data ( Loan Record.xls) • Tentative decisions (based on problem data/common sense/ business considerations) • Evaluation Form for the Presentation is posted on the class website

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