Credit Management

Banking 10
Reference:
Bank Management and Financial
Services
By: Peter Rose and Sylvia Hudgins
Credit Management

Lending Policies and Procedures:

Managing Credit Risk
 Key Topics
1. Types of Loans Banks and
Competing Lenders make.
2. Factors Affecting the Mix of Loans Made
3. Regulation of Lending
 Introduction
• "If you owe the Bank $100, that's your
problem. If you owe the bank $100 million,
that's the Bank's problem."
– J. Paul Getty
 Credit Lending
• It is the principal reason many
financial firms are issued charters by
the State and National Government.
– Legitimate Corporate and Individual
lending
– Reasonable credit pricing inlined with
the determined Market interest rate
 Bank's Economic Function
1. Make loans to fund consumption
2. Make loans to fund Investment Spending

 If correctly done, Credit Lending will:

1. It will create jobs within the lender's market
area.
2. It will convey information about the
borrower's credit quality and enables the
borrower to obtain funds cheaper the next
time.
 Credit Monitoring
• When a lender gets into a serious
financial trouble, it's problem usually
springs from loans that have become
uncollectible due to:
1. Mismanagement
2. Illegal Manipulation
3. Misguided Policies
4. Unexpected Economic downturn
 Loan Portfolio Review
1. It includes a detailed analysis of the
documentation and collateral for the
largest loan.
2. A review of a sample of small loans.
3. An evaluation of loan policies to
ensure they are sound and prudent
in order to protect the public's
money.
 Loan Portfolio Reporting
• At least once a year, BSP, the PDIC,
and Department of Treasury require
each bank to report the composition
of it's Loan Portfolio according to it's
purpose attached to it's balance
sheet.
 Types of Loans
1. Real Estate Loans
2. Financial Institution Loans
3. Agriculture Loans
4. Commercial and Industrial Loans
5. Loans to Individuals
6. Miscellaneous loans
7. Lease Financing Receivables
 Factors determining the Growth
and Mix of Loans
1. Profile of characteristics of the market area it serves
 Loan Participation
 Credit Derivatives
2. Lender Size
 Wholesale Lenders
 Retail Credit
3. The experience and expertise of Management
4. Type of Lending Institution
 Commercial Banks
 Finance Companies
5. Expected yield
 Gross yields- Credit Cards
 Net yields- Real Estate and Consumer loans
 Expected Yields
• What affects the expected yields of
the Loan Portfolio?
1. Lender Size
2. Customer Size
 Regulation of Lending
• Restrictions:
1. Banks are frequently prohibited from making
loans collateralized by their own stock.

2. The total volume of the real estate loan granted

cannot exceed that bank's capital and surplus or
70% of it's total time and savings deposit
(whichever is greater).

3. An unsecured loan to a single customer normally

cannot exceed 15% of a single national bank's
unimpaired capital and surplus account.
 Legal Lending Limit
 Regulation of Lending
4. Restrictions to Insider Loan
5. The Sarbanes-Oxley Act of 2002
6. Community Reinvestment Act of
1977
7. Equal Opportunity Act of 1974
8. Disclosure Laws
 Regulation of Lending
International
1. International Lending and
Supervision Act
2. Uniform Financial Institution Rating
System
 Uniform Financial Institution
Rating System
1. Numerical Rating (1-highest, 5 lowest)
2. Loan Classification
a. Criticized Loans
b. Scheduled Loans
c. Substandard Loans
d. Doubtful Loans
e. Loss Loans
3. CAMELS Rating- Over all Numerical Rating
 Capital Adequacy
 Asset Quality
 Management Quality
 Earnings record
 Liquidity Position
 Sensitivity to Risk
 Challenges in the Bank
Examination Process
1. Rapidly changing technology
2. Mergers and Consolidation
3. Time Vs. Rapid Change

Solution:
 Market Forces
 Private Market Discipline
 Borrowing cost
 Stock Price
 Market Signals
 Establishing a Good Written Loan Policy

• Written Loan Policy

– It gives loan officers and management
specific guidelines in making individual
loan decisions and in shaping the over
all loan portfolio
– Elements of a Well-Written Loan Policy
(please see attached page 527)
 Advantages of having a Well-Written Loan Policy

1. It communicates to employees what procedures

they must follow and what their responsibilities
are.

2. It helps the lender to move toward a loan

portfolio that can successfully blend multiple
objectives such as:
 Promoting profitability
 Controlling Risk Exposure
 Satisfying Regulatory Requirements

***Any exception to the policy must be

documented and reasons should be listed.
 Steps in the Lending Process
1. Finding Prospective Loan Customers
2. Evaluating a Prospective Customer's Character
and Sincerity of Puspose
3. Making Site Visits and Evaluating a Prospective
Customers Credit Record
4. Evaluating a Prospective Customer's Financial
Condition
5. Assessing Possible Loan Collateral and Signing
the Loan Agreement
6. Monitoring Compliance with the Loan Agreement
and other Customer Service needs
 Credit Analysis
What Makes a Good Loan?
• Credit Department
– It is the division or department
responsible for analyzing and making
recommendations on the fate of most
loan applications.
 Credit Analysis
Before Loan Approval
1. Is the Borrower credit worthy? How do
you know?
2. Can the Loan agreement be properly
structured and documented?
3. Can the Lender perfect it's claim against
the assets or earnings of the consumer?
 Credit Analysis
Is the Borrower credit worthy? How do you know?

 The 6 C's of Credit

1.Character
2. Capacity
3. Cash
4. Collateral
5. Conditions
6. Control
 Credit Analysis
Can the Loan agreement be properly structured and documented?

1. Drafting a Loan Agreement

2. Proper Accomodation
3. Banker must act as a Financial
Councelor
4. Imposed Restrictions (Covenants)
 Credit Analysis
Can the Lender perfect it's claim against the borrowers
earning and any assets that may be pledged as Collateral?

• Reasons for taking Collateral:

1. If the Borrower cannot pay, the pledge of collateral gives
the lender the right to seize and sell those assets to cover
what the borrower did not pay back.
2. Collateralization gives the lender a psychological
advantage over the borrower.

• Goal of Lenders for taking Collateral:

1. To precisely define which borrowers assets are subject to
seizure and sale.
2. To document for all other creditors to see that the lender
has a legal enforceable superior claim against the
borrowers assets
 Credit Analysis
Can the Lender perfect it's claim against the borrowers earning and
any assets that may be pledged as Collateral?

• Common Types of Collateral:

1. Accounts Receivables
2. Factoring
3. Inventory
4. Real Property
5. Personal Property
6. Personal Guarantee
 Credit Analysis
Can the Lender perfect it's claim against the borrowers earning and
any assets that may be pledged as Collateral?

• Other Safety Devices to Protect a

Loan: Safety Zones
1. Primary
 Income (Cash Flow)
2. Secondary
Strenght of Customer's Balance Sheet
3. Outer Layer
Personal Guarantees and Pledges
 Credit Management

Lending to Business Firms and

Pricing Business Loans
 Introduction
• "A Banker is a fellow who lends his
umbrella when the sun is shining and
wants it back when it begins to rain."
– Mark Twain
 Brief History of Business Lending

• It has a 2,000-year History.

– Emergence of Competitors (Late 19th to
Early 20th Century)
• In today's world, Loan Officers skilled in
evaluating credit request of firms rank
among the most experiences and highest
paid people in the financial services field,
along with investment bankers.
 Types of Business Loans
A. Short-Term Business Loans
1. Self-Liquidating Inventory Loans
2. Working Capital Loans
3. Interim Construction Financing
4. Security Dealer Financing
5. Retailer and Equipment Financing
6. Asset Based loans
7. Syndicated Loans
 Types of Business Loans
B. Long-Term Business Loans
1. Term Loans
2. Revolving Credit Financing
3. Project Loans
4. Loans to support acquisitions of other
business firms- LBO's
Credit Management

Consumer Loans, Credit

Cards, and Real Estate
Lending
 Introduction
• "If you would know the value of
money, go and try to borrow some."
– Benjamin Franklin
 Types of Loans Granted to
Individuals and Families

1. Residential Mortgage Loans

2. Non-residential Loans
3. Credit Cards and Revolving Credit
 Installment Loans
 Non-Installment Loans
Credit Management

Financial Statement Analysis