Principles Of Banking Ch. 7

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Community Reinvestment Act

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Banks are evaluated and given a public rating on their record of helping to meet the credit needs of their communities, such as making loans to individuals for home mortgages, small businesses, and small farms, including loans to low- to moderate income customers.

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Business Loan

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A loan to a business to meet short or long-term needs. Also know as commercial loans.

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Asset-based financing

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A financing method usually focused on the cash flow of a particular asset or asset group for return on an investment or loan.

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Factor

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A firm that buys a business's accounts receivable and collects on the accounts.

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Commercial Paper

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Negotiable, short-term, unsecured promissory notes in bearer form issued by major corporations with unquestioned credit standing as a means of borrowing.

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Loan Categories

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-Consumer Loans
-Business Loans
-Real Estate Loans
-Government Loans

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Ranges of Bank Loan Terms

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A bank loan term may be as short as 30 days or as long as 30 years.

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Consumer Loan

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A loan extended to consumers, either individually or jointly, primarily for the purpose of buying goods and services for personal use.

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Consumer loans have proven attractive to banks for several reasons:

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-Interest income contributes to bank profits.
Most consumer loans are repaid as agreed.
-Consumer loans are part of full-service banking
-Other bank services, such as deposit products, can be cross-sold to build long-term customer relationships.

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Two broad categories of consumer loan products:

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1) Open end (revolving)
2) Closed-end (installment)

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Open-end Credit

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In an open-end line of credit, a customer may draw on funds for an agreed amount. The balance may fluctuate from zero to the credit line max. Two examples are a home equity line of credit and a credit card.

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Home Equity Line of Credit

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Secured by the customer's residence . Because it is secured, the interest rate typically is lower that for open-end unsecured credit, and the interest paid may be tax-deductible. Funds can be used to remodel your house, buy a car, or take a vacations

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Secured Loan

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A loan for which the customer has pledged some form of collateral to protect the lender in case of default.

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Credit Cards

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Flexible source of credit, cardholder can control how and when to use credit. Cardholder can use the credit line as needed to travel, entertain, or purchase merchandise, paying later. Carry high risk to bank (stolen and fraudulent charges). Usually unsecured, so typically carry high interest rates.

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Closed-end Credit

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Have a specified amount and maturity date. They may be single payment loans or they may amortize over the course of the loan term with payments made in installments on specific dates. Customer receives lump sum up front. For payment, bank may automatically debit account or provide coupons to accompany pmts.

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Amortization

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The periodic reduction of the principal amount due on a mortgage or other term loan. When the gull amount is repaid, the loan is fully amortized.

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Types of Consumer Loans

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Personal, automobile, mobile home, RV, marine(boat), home improvement, home equity or second mortgage, bank card credit, education.

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Promissory Note

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A written document with the customer's(maker's) promise to pay a certain sum of money to the bank(the payee), with or without interest, on demand or on a fixed or determinable future date.

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Two areas of Real Estate Financing:

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1) Short-term construction loans
2) Longer-term mortgage loans

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Construction Loans

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-Usually short term
-Maturities consist with construction period
-Customer makes periodic interest payments on the loan, and at the end of the term the bank may convert it to a mortgage loan.

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Mortgage Loans

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-Closed-end, long term credit
-Terms up to 30 or even 40 years
-Customer pledges property as collateral
-Payments cover interest and principal
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Adjustable Rate Mortgage (ARM)

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A mortgage on which the rate is subject to periodic adjustment. The rate usually is tied to a widely published market index or rate of interest. Typically terms are between (5-15 years)

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Prime Rate

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The interest rate the bank will offer its most creditworthy customers and the base rate used to set interest rates for other loans.

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Consumer Loan Pricing Methods

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1)Simple Interest
2)Discount Method
3)Add-on Method
4)Rule of 78s
5)Compensating Balance

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1) Simple Interest

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Interest is computed by applying a daily periodic interest rate to the principal amount outstanding. Thus, if the customer pays additional amounts on principal, the loan's total interest amount is reduced.

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2) Discount Method

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Interest payment is deducted up fron from the requested loan amount, so that the borrower receives less principal than requested.

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3) Add-on Method

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Total interest odue on the loan is calculated as principal loan amount times the interest rate. This amount is then added to the principal and the total is paid in equal installments over the life of the loan.

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4) Rule of 78s

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A determination of the amount of interest rebate a customer is entitled to receive if the loan is paid before the maturity date.

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5)Compensating Balance

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The interest rate applied is determined by the balance the customer must maintain at the bank.

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Foreclosure

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A legal procedure undertaken to permit a creditor to sell property that is collateral for a defaulted loan.

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The 2 Business Loan Categories:

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Short-term loan and Long-term loan

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Short-term Loan

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Repayable in one year or less. For businesses, used to finance current assets, such as inventory or accounts receivables.

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Long-Term Loan

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Repayable in more than one year. For businesses, used to finance fixed assets, such as equipment and real estate.

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Working Capital Loan-(Type of Business Loan)

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A short term (typically 30 to 90 days) to provide immediate funds for a one-time need, such as raw materials for a toy manufacturer to make toys for the holiday season.

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Working Capital Line of Credit-(Type of Business Loan)

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Funds provided, like a consumer line of credit, for businesses to acces for recurring financing needs throughout the year. Banks often require payment with 30 days. Rate typically variable.

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Term Loan-(Type of Business Loan)

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Loans with maturities of 1-5 years used to purchase fixed assets other than real estate. PMT schedule usaully tied to useful life of asset. EX: Plant equipment financed longer than personal computer

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Participation Loan-(Type of Business Loan)

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A loan made to a single customer by two or more banks acting together. Usaully made when the amount exceeds one bank's loan policy or legal lending limit. AKA: syndicated loans. Banks share the risk

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Indirect or third Party loan

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Loans made to customers of dealerships, such as automobile or appliance dealers. Banks work directly with and obtain loan applications through the dealers.

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Floor Plan Loan

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Loans to a dealer to finance consumer goods for display and sale. The consumer goods, such as automobiles or appliances, are collateral for loan.

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Letter of Credit

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An instrument issued by a bank that substitutes the bank's credit for the credit of the buyer of goods. This can allow a buyer to pay after goofs have been received and this conduct more transactions.

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Asset-based Loans

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Short-term loans secured by salable business assets, such as inventory or accounts receivables.

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Leveraged-Buyout (LBO)

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Loans made to finance mergers and acquisitions. One example of LBO loan use is to help finance the purchase of a company by a group of investors, including insiders, who plan to return value to the business under different management.

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Two Methods of Business Loan Pricing:

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1)Cost-plus Pricing
2)Relationship profitability pricing

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Cost-plus Pricing

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The interest rate is determined by setting it at a fixed amount or percentage above the costs to make the loan. Cost include such items as the cost to the bank to raise funds for the loan amount, an amount for default risk, and a profit margin.

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Affordable Housing

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1)Veterans Benefit Administration(VBA)
2)Federal Housing Administration(FHA)
-loans available to those that might not be able to afford them

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Access to Higher Education

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Student loan programs offer low-interest or fully subsidized interest loans, with repayment deferred until after the student graduates.

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Small Business Development(SBA)

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Guarantees loans made to qualified small businesses, thus transferring some of the risk from the lender to the SBA.

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Other Government Sponsored Lending

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Through the secondary mortgage market, "Fannie Mae" and "Freddie Mac" buy loans granted by mortgage lenders and issue mortgage backed securities(MBS) for sale to investors.

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Secondary Mortgage Market

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Transactions involving selling and purchasing mortgages. Mortgage loans originate in the primary mortgage market. The later sale of those loans occurs in the secondary market.

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Mortgage-backed securities(MBS)

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Pools of mortgages used as collateral for the issuance of securities in the secondary market. Commonly referred to as "pass through" certificates because payments on the principal and interest of the underlying loans are passed through to investors. The interest rate on the security is lower than the interest rate of the underlying loan to allow for payment of servicing and guaranty fees.

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Government National Mortgage Association(Ginnie Mae)

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Guarantees the principal and interest pools of residential loans insured by the FHA or guaranteed by the VA. GNMA-approved lenders with a pool of such loans having similar rates and maturities can issue an MBS in the amount of the loan pool.

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The Lending Process(1-4)

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1)Application and Interview
2)Investigation
3)Documentation
4)Credit Administration

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Payment Protection

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Products that sold in conjunction with loans so that the loan can be paid if the customer dies, is injured or disabled, or loses a source of income.

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1)Application and Interview

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-Understand customer needs, supporting documents, and what the loan product customer needs.
-After this step is completed, banks decide whether to continue, deny, more info, direct to other financing sources.

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2)Investigation

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-Investigation usually consist of verifying employment, income, credit history, and current debt.
-Most lenders use 5 C's to analyze creditworthiness.

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5 C's of Credit

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1) Character
2)Capacity
3)Collateral
4)Capital
5)Conditions

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1)Character

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The borrower's willingness and determination to repay the loan. Usually considered the most important of the 5.

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2)Capacity

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The borrower;s ability to repay the loan, that is, to generate enough funds and manage those funds to make loan payments.

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3)Collateral

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The assets the borrower pledges as a source of loan repayment in case of loan default. It usaully is viewed as a secondary source of repayment only.

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4)Capital

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Other assets that may be used to pay the loan. For businesses, capital often consists of the equity an owner has in the business.

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5)Conditions

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External factors that may affect the borrower's ability to repay the loan, such as a change in employment.

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Types of Credit Information

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-credit history
-income
-employment
-residence
-collateral value

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Sources of Credit Information

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-application
-internal bank files
-directly from other financial institutions
-credit reporting agencies
-public records

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Credit Files Contain:

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-Copies of loan documents
-financial information
-Credit inquiries and reports
-Collateral information
-Correspondence and memos
-information like business annual reports

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Sample Loan Documentation for a home equity line of credit-

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-promissory note with disclosure of credit
-mortgage agreement
-insurance binder
-title search
-appraisal
-flood determination
-rescission notice

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Security Interest

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The right a lender has to obtain possession of the collateral, sell it, and retain the proceeds(up to the amount of the remaining debt) if the customer is unable to repay the loan.

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Perfection

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The process by which a secured party protects its security interest from third parties by possession, certificate of title, control, or filing or recording documentation of the security interest in local or state public records.

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Loan Review-

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The function of examining loan documents to ensure they are accurate, complete, and conform to laws and regulations and the bank's loan policies and procedures.

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Substandard Loan-

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A loan whose risk is high given the collateral and the loan's structure.

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Doubtful Loan-

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A loan that probably will not be collected and poses default risk.

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Loss Loan

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An uncollectible loan or a loan that is not an appropriate asset for the bank.

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Collection and Recovery Objectives

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-Keep delinquencies and losses within set limits.
-Generate loss recovery at desired levels
-Counsel customers who have difficulty managing debt
-ensure adherence to bank objectives.
-manage collection and recovery efficiently

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Annual Percentage Rate(APR)

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The finance charge expressed as an annual percentage of the funds borrowed. It results from an equation that considers that amount financed, the finance charge, and the term of the loan. APR allows a comparison of credit costs regardless of the dollar amount of the costs or the length of time over which payments are made.

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Redlining

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Excluding potential loan customers because they are from a certain geographic area, regardless of whether they are depositors or meet all other criteria of creditworthiness.

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Medical Information

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Under the FACT act, which amended FCRA, information, oral or recorded in any form, created by or derived from a health care provider or the consumer that relates to the past, present, or future physical, mental, or behavioral health or condition of an individual, the provision of health care, or payment for the provision of health care.