Fundamentals of Credit II

Topics for Discussion

• 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
Bank’s income
• Interest
• Other investments (non-interest)
Introduction
• However, risky or not, the principal reason many
financial firms 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 reasonably
• Loans support the growth of new businesses and jobs
within the lender’s market area
• Loans frequently convey information to the
marketplace about a borrower’s credit quality
• The lending process bears careful monitoring at all
times
Types of Loans
• Real Estate Loans
• Financial Institution Loans
• Agriculture Loans
• Commercial and Industrial Loans
• Loans to Individuals
• Miscellaneous Loans
• Lease Financing Receivables (Post paid, rent to
own, car loan)
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 (written document)
• Expected yield of each type of loan
• Regulation (ex. AgriAgra 10% loan)

General rule: A lending institution should make the

types of loans for which it is the most efficient
producer
Regulation of Lending
• The mix, quality, and yield of the loan
portfolio are heavily influenced by regulation
• Examples of lending regulations:
▫ BSP’s Single Borrower’s Limit (25% of the
net worth of the bank) (Because of Risk
Aversion)
▫ Minimum Reserve Requirement (20%)
• Any loans made are subject to examination
and review
Financial Correlation
1 bank : all banks
RR : loan

RR = Initial Deposit / 20%

RESERVE REQUIREMENT: (20%)

Initial Deposit to Bank A $100
Deposit to Bank B $ 80
Bank C $ 64
Bank D $ 51.2
BSP Resolution 783
• Before granting a loan, banks must exercise proper
caution to ascertain that the debtor is capable of
fulfilling his commitments to the bank.
• Classification of Loans aside from current and past due
▫ Unclassified Loans (Good Payer)
▫ Classified loans (Troubled Loans)
▫ Substandard loans (less than 50%)
▫ Doubtful loans (more than 50%)
▫ Loss loans (no chance to be paid)
RA 3765 – Truth in Lending Act
• It is the policy of the State to protect its citizens from a lack of
awareness of the true cost of credit to the user by assuring a
full disclosure of such cost:
• (1) the cash price or delivered price of the property or service to be
acquired;
• (2) the amounts, if any, to be credited as down payment and/or trade-
in;
• (3) the difference between the amounts set forth under clauses (1)
and (2);
• (4) the charges, individually itemized, which are paid or to be paid by
such person in connection with the transaction but which are not
incident to the extension of credit;
• (5) the total amount to be financed;
• (6) the finance charge expressed in terms of pesos and centavos; and
• (7) the percentage that the finance bears to the total amount to be
financed expressed as a simple annual rate on the outstanding unpaid
balance of the obligation.
Loan Policy
• Important in order to meet regulatory standards
• What should a written loan policy contain?
• A goal statement for the entire loan portfolio
• Specification of lending authority of each loan officer and
loan committee
• Lines of responsibility in making assignments and
reporting information
• Operating procedures for soliciting, evaluating and
making loan decisions
• Required documentation for all loans
Loan Policy (Continued)
• Lines of authority for maintaining and reviewing credit
files
• Guidelines for taking, evaluating, and perfecting loan
collateral.
• Procedures for setting loan rates and fees and the terms
for repayment of loans
• A statement of quality standards applicable to all loans
• A statement of the preferred upper limit for total loans
outstanding
• A description of the lending institution’s principal trade
area
• Procedures for detecting and working out problem loan
situations.
Steps in the Lending Process
1. Finding Prospective Loan Customers
2. Evaluating a Customer’s Character and Sincerity of
Purpose
3. Making Site Visits and Evaluating a Customer’s
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
Reason for lending money
• Power is shifting from the bank to the borrower
• There is a strong competition on banks
What Makes a Good Loan?
1. Is the Borrower Creditworthy? The Cs of
Credit
▫ Character
▫ Capacity
▫ Collateral
▫ Conditions
▫ Capital
What Makes a Good Loan?
2. Can the Loan Agreement Be Properly Structured and
Documented?
▫ This requires drafting a loan agreement that meets the
borrower’s need for funds with a comfortable repayment
schedule
▫ If a major borrower gets into trouble because of an
inability to service a loan, the lending institution may find
itself in trouble
▫ Proper accommodation of a customer may involve lending
more or less money than requested over a longer or
shorter period
What Makes a Good Loan?
3. Can the Lender Perfect Its Claim against the Borrower’s
Earnings and Any Assets That May Be Pledged as 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
▫ Factoring
▫ Inventory
▫ Real Property
▫ Personal Property
▫ Personal Guarantees
Safety Zones Surrounding Funds Loaned in
Order to Protect a Lender
Sources of Information Frequently Used in Loan Analysis and
Evaluation by Lenders and Loan Committees
Parts of a Typical Loan Agreement
• The Promissory Note
• Loan Commitment Agreement
• Collateral
• Covenants
▫ Affirmative (to do something) (ex. Green bonds)
▫ Negative (not to do something)
• Borrower Guaranties or Warranties (promises of the
borrower to protect the lender)
• Events of Default (non compliance of loan
agreement)
PERSONAL GUARANTEE
SMART ------ BDO P150M

Parent Company ----- TEL

To pay monthly : P10M

this month : P7M
TEL Paid : P3M
Loan Review
1. Carrying out reviews of all types of loans on a periodic basis
2. Structuring the loan review process
▫ Record of borrower payments
▫ Quality and condition of collateral
▫ Completeness of loan documentation
▫ Evaluation of borrower’s financial condition
▫ Assessment as to whether the loan fits with the lender’s
loan policies
3. Reviewing Largest Loans Most Frequently
4. Conducting More Frequent Reviews of Troubled Loans
5. Accelerating the Loan Review Schedule if Economy or
Industry Experiences Problems
Loan Workouts
• Loan workout – the process of recovering funds from a problem
loan situation
• Warning Signs of Problem Loans
1. Unusual or unexpected delays in receiving financial statements
2. Any sudden changes in accounting methods
3. Restructuring debt or eliminating dividend payments or changes in
credit rating
4. Adverse changes in the price of stock
5. Losses in one or more years
6. Adverse changes in capital structure
7. Deviations in actual sales from projections
8. Unexpected or unexplained changes in deposits
Loan Workouts (continued)
• What steps should a lender take when a loan is in trouble?
1. Do not forget the goal: Maximize full recovery of funds
2. Rapid detection and reporting of problems is essential
3. Loan workout should be separate from lending function
4. Should consult with customer quickly regarding possible
options
5. Estimate resources available to collect on loan
6. Conduct tax and litigation search
7. Evaluate quality and competence of management
8. Consider all reasonable alternatives

▫ Preferred option: Seek a revised loan agreement