Topic 10 - Managing Loans Flashcards
(47 cards)
1
Q
credit philosophy
A
An ADI must have a clear credit philosophy which incorporates the organisation’s attitude toward risk and determines it’s priorities
2
Q
credit culture
A
The ADI has a appropriate credit culture if the behaviour of its staff is closely aligned to its philosophy
3
Q
The objective of the credit management is to
A
is to control –minimise –loan losse
4
Q
ADIs often conduct “autopsies” to determine the reason for a loan loss and prevent a recurrence Common reasons include:
A
Failure to receive and analyse financial statements
Failure to correctly value collateral
Repeatedly renewing or rewriting loans despite financial difficulty
Inappropriate lending to high-risk borrowers
Lending decisions made on the basis of personal relationships
5
Q
The main types of collateral are:
A
Real property
Personal property in the lender’s possession
Personal property in the borrower’s possession
6
Q
Real property
A
a registered mortgage is taken out over land and buildings
7
Q
Personal property in the lender’s possession
A
–e.g. shares or cash deposit
8
Q
Personal property in the borrower’s possession
A
a charge or equitable mortgage is registered
9
Q
loan review function
A
This involves periodically auditing loans and the financial situation of borrowers in order to detect any deterioration in loan quality
10
Q
Impaired assets are classified as:
A
Non-accrual loans
Restructured loans
Assets acquired through security enforcement
11
Q
Non-accrual loans
A
loans where interest is no longer being paid (typically more than 60 days overdue)
12
Q
Restructured loans
A
loans where the terms have been renegotiated because the financial difficulties
13
Q
Past due loans
A
where interest payments are overdue –are not technically impaired assets, but are reported due to the risk they represent
14
Q
The main types of lending are:
A
- Small business lending
- Agricultural loans
- Corporate lending
- Project financing
- Syndicated loans
15
Q
The main types of loans are:
A
- Overdrafts
- Commercial bills
- Term loans
- Third-party credits
- Lease financing
16
Q
Overdrafts
A
a company is permitted to overdraw its current account up to a pre-agreed limit
17
Q
Commercial bills
A
A bank may be asked to set up an acceptance or endorsement facility, which typically lasts 3 to 5 years, and effectively gives a company access to medium-term funding, albeit subject to review every time an individual bill matures
18
Q
Term loans
A
This refers to a business loan with a term exceeding one year
19
Q
Third party credits
A
Some types of business finance involve contracting with third parties: Guarantees and letters of credit Accounts receivable financing Factoring Inventory financing
20
Q
Guarantees and letters of credit
A
A bank will guarantee the payment of funds to a third party or guarantee performance under a contract
21
Q
Accounts receivable financing
A
Funds are advanced using accounts receivable as collateral, and the cash flow from the debtorsis used to repay the loan
22
Q
Factoring
A
This involves the outright purchase of a customer’s accounts receivable, with the ADI becoming responsible for collection
23
Q
Inventory financing
A
Funds are advanced using inventory as collateral, and the cash flow from the sale of inventory is used to repay the loan
24
Q
Lease financing
A
A finance lease is an alternative source of funding for capital equipment
- A finance lease is not cancellable by the lessee, and the term of the lease is for most of the asset’s life
- Under a finance lease, instead of lending money to buy the asset, the ADI (the lessor) retains ownership of the asset and allows the lessee to use it in return for lease payments
- The lessee usually has the option to buy the asset at the end of the lease contract
25
Lending decisions are based primarily on
The character and soundness of the borrower
The purpose of the loan
The available sources of repayment
26
Debt/Equity ratio
Total Debt/Total Equity
27
Interest Coverage Ration
Profit before tax and Interest / Interest Expenses
28
Average Collectio Period
Accounts Receivable / Sales per day
29
Inventory Turnover Ratio
Average Cost of Goods Sold / Average Inventory
30
Consumer lending
refers to loans to householders –i.e. non-business customers
31
The main types of credit issued to consumers are:
1. Personal loans
2. Credit cards
3. Home loans
32
Personal loans
Personal loans can be made for a variety of purposes (e.g. cars, travel, furniture, debt consolidation) and may or may not be secured
The most common is an instalment loan
A line-of-credit facility is also one
33
instalment loan
which has a fixed term and is repaid with periodic payments of interest and principal
34
ine-of-credit facility
is similar to an overdraft, allowing personal accounts to be overdrawn
35
The financial affairs of a loan applicant need to be carefully analysed in order to assess his or her capacity to repay the loan Two broad methods are used:
The gross income method is based on the adequacy of the surplus of gross income over fixed obligations
The net income method also considers the average living expenses of the family unit
36
Discuss what is meant by an ADI’s credit culture. How could this be effectively conveyed within an organisation?
An ADI’s credit culture captures the organisation’s attitude to risk in lending. It exists to ensure that the credit philosophy and loan policy is appropriately supported and communicated to all staff. On a day‐to‐day basis the credit culture is strong if each individual’s decision making is consistent with management priorities.
37
Describe how an ADI’s credit philosophy is reflected in the risk and return of the loan portfolio.
The credit philosophy of an organisation is dependent in the profit expectation of the owners and shareholders. A credit philosophy which emphasises strong loan growth will have more flexible credit standards and be more accepting of higher risk assets. Expected returns will be higher, but given the higher risk profile of assets, revenues will tend to be more volatile. A more conservative credit philosophy, on the other hand, will tend to have higher credit standards, slower growth and a lower risk asset portfolio, which will generate a steadier revenue stream.
38
The lending experience of Australian banks in the late 1980s and subsequent upsurge in impaired loans is often said to have led to high standards of credit risk management in recent years. Discuss the lending practices and environment of the late 1980s and how this might differ in the current climate.
In Australia in the 1980s, asset price inflation, strong demand from corporate borrowers and increased competition in the banking sector led banks to a rapid expansion in lending. This expansion occurred in early post‐deregulation years when banks were emerging from a period of ‘credit rationing’, that is, banks would allocate a limited amount of funds to the lowest risk options. Consequently, credit risk management tools were very basic. In addition, banks were using lending techniques that have been largely discredited since such as negative pledges and ‘name lending’. A sweeping change in policy was forced upon banks when many of these loans failed. The introduction of capital adequacy requirements in 1988, better credit risk management skills and tools in ADIs, and the separation of loan sales and credit analysis functions have ensured that the lending environment of the 2000s has changed significantly.
39
Conflicts of interest and opportunities for unethical conduct can arise for lenders within the normal course of their duties. Identify three such situations and discuss how the lender should respond. Does the Bankers’ Code of Conduct provide appropriate solutions?
Lenders, particularly those who deal directly with the customer, can sometimes find themselves in a position where a conflict of interest or the possibility of unethical conduct may arise. Typical situations might include the offer of a valuable gift or hospitality to influence a lending decision, lending to a borrower where the lenders own property is being purchased or where an opportunity to invest comes to the lender on the strength of confidential information.
40
Outline the different categories of loans that comprise impaired loans and give examples of each.
There are three types of impaired loans: non‐accrual items, restructured items and other assets acquired through security enforcement. A typical non‐accrual item would be a mortgage loan where payment is overdue by 90 days and where the sale price, less the cost of selling, is less than the principal and accrued interest owed on the loan. A restructured item may be one that is not achieving a commercial rate of return because the loan repayments have been reduced due to financial difficulties experienced by the borrower. An asset acquired through security enforcement might be a house that has been repossessed due to default on a mortgage loan.
41
Describe the different categories of lending to the business sector.
Lending to the business sector is generally divided into five categories. These are small business lending, agricultural loans, corporate lending, project financing and syndicated loans. There are some special features associated with each of these types. Small business loans are given to firms that have less than 200 employees. These businesses are dependent on bank finance for purchasing fixed assets as well as for working capital needs. A typical problem in small business financing is that of over‐trading. Agricultural borrowers have three main financial needs; long‐term finance for the purchase of land; medium‐term finance for acquisition of plant and equipment; and short‐term finance to meet seasonal needs. Corporate lending refers to loans made to large corporations. These include large public companies, private companies and statutory bodies. Detailed financial data of such corporations is available and it requires financial expertise to analyse the data. Project financing is resorted to when a very large financial investment is involved. It is the project’s own merit rather than sponsor’s financial strength that determine its viability. Loan syndication is based on the fundamental tenet of spreading the risk and is usually used to finance medium to long‐term projects.
42
What is a commercial bill and why has it become a popular form of short‐term financing?
A commercial bill is a negotiable instrument that may be bought and sold in the market. Banks mainly operate the market. When used as a form of credit, the role of the banks is simply to lend its name to the bill thereby guaranteeing repayment if the customer defaults. Suppose Alice buys goods from Ben. Then Alice can make payment to Ben in
many ways. Alice can pay cash (provided she has it ready), pay cheque (provided she has balance in the account); alternatively, she could draw a bill, get it endorsed by her bank and give it to Ben, who is ready to accept it because if Alice fails, bank will pay Ben after say 3 months (maturity of the bill). Effectively, Ben has lent money to Alice on the security of bank‐endorsed bill. Thus bank’s own money is not tied. For endorsing the bill, bank will charge some fee to Alice. It is a convenient form of short‐term financing and hence has become popular. Other forms like overdrafts are expensive.
43
Distinguish between accounts receivable financing and factoring?
In accounts receivable financing, the ADI lends money against an agreed percentage of receivables that are assigned to it. The borrowing firm continues its regular credit and collection functions and its customers are not notified of the assignment of their debt to the lender. In factoring, a lender actually purchases selected receivables from a borrower at a percentage of face value (discount). The borrower’s customers are notified of the transaction, and all payments are subsequently remitted directly to the lender. The difference between the two methods lies mainly in a change in ownership of the receivables under factoring and a shift in the responsibility of collection. In factoring, the lender rather than the borrower, is responsible for the collection of the receivables, whereas under accounts receivable financing, the borrower maintains responsibility for collections.
44
What are the different types of consumer credit available from Australian banks?
The different types of consumer credit available from Australian banks include personal loans, credit card loans, margin loans and home loans. Home loans are a major category of consumer finance. Personal loans include loans for purchase of car or boat, furniture and other household items including a holiday. Credit card loans represent a revolving credit.
45
Explain the major changes that have taken place in the Australian home loan market in recent years.
Structural change in the Australian home loan market has been accelerated by technological developments and the emergence of a market for mortgage‐backed securities (MBS). These factors have ensured that new entrants to this market have been able to access customers and a funding base without the need for a traditional branch network, thereby ensuring low distribution costs. New entrants have often specialised in home loans only.
46
Enumerate the various steps involved in consumer credit analysis.
(a) determine loan purpose and amount
(b) obtain information on consumer credit, personal financial statements and income tax returns
(c) investigate and verify information
(d) analyse financial statements and cash flow
(e) evaluate collateral if required
(f) price and structure the credit
(g) negotiate with the applicant.
47
‘Electronic methods are providing a cost‐effective alternative to traditional branch banking.’ Do you agree?
Delivery of financial services can be undertaken by way of automated teller machines (ATMs), electronic funds transfer at point of sale (EFTPOS), telephone banking and Internet banking. The data provided in Table 12.10 of chapter shows the growing importance of electronic delivery methods. ATM transactions cost less than half and EFTPOS transactions cost around one‐quarter of over‐the‐counter transactions. These data shows that electronic delivery of financial services is proving very cost‐effective.
