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Chapter Sixteen

Lending Policies and Procedures: Managing Credit Risk


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Quick Quiz
Why is lending so closely regulated by state and federal authorities? What is the CAMELS rating, and how is it used? List several elements of a good written loan policy.

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Quick Quiz
What are the typical steps followed in receiving a loan request from a customer? What three major questions or issues must a lender consider in evaluating nearly all loan requests? Explain the following terms: character, capacity, cash, conditions, and control. 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
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Key Topics
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
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Loan Review and Loan Workouts


2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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Types of Loans Made By Banks


Real Estate Loans Financial Institution Loans Agriculture Loans Commercial and Industrial Loans Loans to Individuals Miscellaneous Loans Lease Financing Receivables

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Loans Outstanding for U.S. Banks (2007)

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Factors Determining the Mix of Bank Loans


Characteristics of Market Area Lender Size Experience and Expertise of Management Expected Yield of Each Type of Loan

Regulations
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Regulation of Lending: CAMELS Rating System


Capital Adequacy Asset Quality Management Quality Earnings Record Liquidity Position Sensitivity to Market Risk

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Asset Quality
Criticized Loans Scheduled Loans Adversely Classified Loans
Substandard Loans Doubtful Loans Loss Loans

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Regulators Use of Market Forces


Because the Quality of Examination Information Decays Very Quickly Regulators are Starting to Use Market Forces and Private Market Discipline to Monitor Bank Behavior

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Establishing a Good Written Loan Policy


Goal Statement for Banks 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
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Banks Written Loan Policy (cont.)


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 Banks Principal Trade Area Procedures for Detecting, Analyzing and Working Out Problem Loans
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Steps in the Lending Process


Finding Prospective Loan Customers Evaluating a Customers Character and Sincerity of Purpose Making Site Visits and Evaluating a Customers Credit Record Evaluating a Customers Financial Record Assessing Possible Loan Collateral and Signing the Loan Agreement Monitoring Compliance with the Loan Agreement and Other Customer Service Needs
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The Six Basic Cs of Lending


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 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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Common Types of Loan Collateral


Reasons for Taking Collateral Types of Collateral:
Accounts Receivables Factoring Inventory Real Property Personal Property Personal Guarantees
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Information About Consumers


Consumer-Supplied Financial Statements Credit Bureau Reports Experience of Other Lenders Verification of Employment Verification of Property Ownership The Web

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Information About Businesses


Financial Reports Supplied by the Borrowing Firm Copies of Board of Directors Resolutions or Partnership Agreements Credit Ratings Dun & Bradstreet, Moodys, Standard & Poors New York Times, Wall Street Journal, Other Business Publications Risk Management Associates (RMA), Dun & Bradstreet Industry Averages The World Wide Web
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Information About Governments


Government Budget Reports Credit Ratings Assigned to Government Borrowers By Moodys, Standard & Poors, Fitch Web

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Lending the Old Fashioned Way? (box)


Traditional Lending Model Deregulation of the 1980s and 1990s
New Lending Model Financial Innovations, Such as Securitization, and Their Effect on Lending Mix and Policies (streamlined loans)

Mortgage Market Problems, 2007

Newer Lending Paradigm or Back to the Basics? An Increased Coordination Among Financial Regulators in Different Countries McGraw-Hill/Irwin
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Parts of a Typical Loan Agreement


The Promissory Note Loan Commitment Agreement Collateral Covenants
Affirmative Negative

Borrower Guaranties and Warranties Events of Default

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Loan Review
Examination of Outstanding Loans to Make Sure Borrowers are Adhering to Their Credit Agreements and the Bank is Following Its Own Loan Policies

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Loan Review Procedures


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 Borrowers Financial Condition Assessment as to Whether Fits with Lenders Loan Policies

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Loan Review Procedures (cont.)


Reviewing Largest Loans Most Frequently Conducting More Frequent Reviews of Troubled Loans Accelerating the Loan Review Schedule if Economy or Industry Experiences Problems

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Warning Signs of Problem Loans


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
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Loan Workouts
The Process of Resolving a Troubled Loan So the Bank Can Recover Its Funds

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Loan Workout Process


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
McGraw-Hill/Irwin Bank Management and Financial Services, 7/e 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

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