slike bài giảng quản trị ngân hàng chương 6 lending to business and pricing business loans

Self-liquidating inventory loans :  used to finance the purchase of inventory, taking the advantage of cash cycle in a business firm  Demand for traditional inventory loans is on the

AND PRICING BUSINESS

LOANS

Chapter 6

Key topics

1. Types of business loans: short- and long-term

2. Analyzing business loan requests

3. Collateral and contingent liabilities

4. Sources and uses of business funds

5. Pricing business loans

6. Customer profitability analysis (CPA)

Short term business loans

1 Self-liquidating inventory loans :

 used to finance the purchase of inventory, taking

the advantage of cash cycle in a business firm

 Demand for traditional inventory loans is on the

decline due to the development of the JIT (just

in time) and supply chain management techniques

Self-liquidating inventory loans:

Cash cycle…

1. Cash is spent to acquire inventory

2. Goods are produced or shelved and listed for sale

3. Sales are made (often on credit)

4. The cash received is used to repay the

self-liquidating loan

Short term business loans

2 Working capital loans : closest to self-liquidating loans

 Bank can set up a credit line (max funding need) in a certain

short period (a few months)

 Loans can be renewed provided that the borrower pay off all

significant portion of the loan before the renewal

 Loans are secured by account receivables, pledges of inventory

 Borrower has to pay floating interest rate on disbursed amount

& a commitment fee is charged on unused credit line

 Compensating deposit balances may be required.

Short term business loans

3 Interim construction loans : support the construction of

homes, apartments, office buildings, etc

 Fund supplied to hire workers, lease construction equipments,

purchase building materials & develop land

 The loan is paid off with a longer-term mortgage loan issued

by another lender

 “Mini-permanent loan” providing fund for the construction

and early operation of a project in 5-7 years

Short term business loans

4 Security dealer financing :

 short-term (overnight to few days) financing new securities

purchase backed by the dealers’ holdings of government

securities as collateral

 Can be extended to investment banking firm in underwriting

new securities issued by the government or firms

 Can be lent directly to businesses and individuals in buying

stocks, bonds, options, etc

 Margin requirements are enforced (≤ 50% of acquired

securities)

Short term business loans

5 Retailer and Equipment financing :

 Banks finance receivables that dealers selling automobiles,

home appliances, furniture, business equipment,… take on

they write installment contracts to cover customer purchase

 Contracts are purchased by lenders at an interest rate varying

with the borrower risk, collateral quality and loan terms

 “Floor planning”: lender finances the dealer’s goods purchase

from manufacturer and be paid as goods are sold

Short term business loans

5 Asset-based financing :

 Credit secured by the shorter-term assets of a firm that are

expected to roll over into cash in the future

 Lender commits funds against a specific % of book value of

outstanding receivables or inventory

 The borrower retains title to the asset pledged in most cases

 Factoring: lender takes on responsibility of collecting

receivables Due to higher risk → higher discount rate and

loan accounts for a smaller fraction of receivable book value

Short term business loans

5 Asset-based financing :

 Credit secured by the shorter-term assets of a firm that are

expected to roll over into cash in the future

 Lender commits funds against a specific % of book value of

outstanding receivables or inventory

 The borrower retains title to the asset pledged in most cases

 Factoring: lender takes on responsibility of collecting

receivables Due to higher risk → higher discount rate and

loan accounts for a smaller fraction of receivable book value

Short term business loans

6 Syndicated loans (SNCs) :

 Loans package extended to a corporation by a lender group

 Lender aims to reduce risk of large loans and earn fee income

(facility fee to open credit line or commitment fee to keep

credit available)

 Many SNC loans are traded in the secondary (resale) market

carrying interest rate based on LIBOR on Eurodollar deposits (1-4% above LIBOR)

Long-term business loans

1. Term loans

2. Revolving credit lines

3. Project loans

4. Loans to support acquisitions of other business firms

• Question : What are the essential differences between

various short- and long-term business loans?

Term loans

Term loans are designed to fund long-term

business investment (equipment or construction)

1. A lump-sum loan is approved

2. Payment is made by amortization monthly/quarterly

3. Repayment source is from business earnings

4. Payment is scheduled based on firm’s cashflow cycle

5. Collateralization is made by fixed assets owned

either by the borrower or the guanrantee

6. Interest rate is either fixed or floated and higher than

short-term rate due to higher risk

7. “Bullet loan”: interest is paid periodically and no

principal is made till maturity date

Term loans:

attention should be paid to….

1. Qualification of the borrower’s management

2. Quality of accounting & auditing system

3. The borrower’s continuous filling in periodical financial

statements

4. The lender’s priority in claiming the borrower’s pledged

assets

5. Adequate insurance coverage

6. The borrower’s risk exposure to technology risk

7. Length of time before the project can generate positive cash

flow

8. Trend in market demand

9. Strength of borrower’s net worth posistion

Revolving credit lines

 Allowing the customer to borrow up to pre-specified limit,

repay all or a portion of the borrowing and re-borrow as

necessary until the credit line matures

 Being one of the most flexible business loan, granted

without specific collateral and maybe short-term or cover a period as long as 5 years

 Useful when firms are uncertain about timing of future cash

flow and borrowing need magnitude

 Help even out fluctuations in business cycle

 Loan commitment fee is charged on unused portion of

credit line or entire credit amount available

Project loans

 The most risky of all business loans to finance fixed asset

construction designed to generate revenue in future (oil

refineries, power plants, harbor facilities…)

 Risks are large and numerous, due to

 Large funding is involved

 Project maybe delayed caused by weather or material

shortage

 Laws and regulations in the project location are negatively

changed

 Interest rate change adversely affects the ability to pay

 Loans are granted to several companies jointly sponsoring the

project and/or the project is co-financed by several lenders for risk sharing

Project loans (cont.)

 Project loan may be granted on

 Recourse basis: lender can recover funds from the

sponsoring companies if the project fails to repay as planned

 Non-recourse basis: no sponsor guarantees, project

stands or falls on its own merit → higher loan rate and more sponsor’s capital contribution due to higher risk

Loans to support firm acquisitions

 Loans to finance mergers/acquisitions of businesses

 Most noted: LBOs (leveraged buyouts)

 Firm purchased is financed heavily by debt in the belief

that revenues can be raised higher than debt costs

 Frequently optimistic assumptions have turned to be wrong

and loans have turned delinquent

1 How business loans are classified in Vietnam?

2 What are the essential differences between various

short- and long-term business loans?

3 What special problems does business lending

present to the management of a business lending institution?

Loan types (Decision 1627/2001/QD-NHNN)

1- Single loan (Cho vay từng lần): short- &long-term

2- Credit line loan (Cho vay theo hạn mức tín dụng): short-term3- Project loan (Cho vay theo dự án đầu tư): long-term

4- Syndicated loan (Cho vay hợp vốn): short- &long-term

5- Installment loan (Cho vay trả góp): long-term for consumers6- Stanby credit line loan (Cho vay hạn mức tín dụng dự

Problems of business loans

Though business loans are usually considered among the

safest types (low default rate), these loans:

 average much larger in dollar volume than other loans →

excessive risk of loss and, if a substantial number of loans

fail, can lead to failure

 business loans are usually much more complex financial deals

than most other kinds of loans, requiring larger numbers of personnel with special skills and knowledge → increase the magnitude of potential losses unless the business loan

portfolio is managed with great care & skill

Analyzing business loan application

 The lender’s margin for error is narrow, due to:

 Large loan denomination

 Yield spread reduction because of competition for best customers

→ requiring special care by

 Asking more repayment sources from borrowers

 Analyzing the borrower’s financial statements

 Pricing the loan correctly to cover costs & be competitive.

Sources of repayment for business loans

 The borrower’s profits or cash flows

 Business assets pledged as collateral

 Strong balance sheet with ample marketable assets

and net worth

 Guarantees given by businesses

Analyzing business loan applications

 Common size ratios of customer over time

 Financial ratio analysis of customer’s financial

statements

 Current and pro forma sources and uses of funds

statement

Financial ratio analysis

 Control over expenses

 Operating efficiency

 Marketability of product or service

 Coverage ratios: measuring adequacy of earnings

 Liquidity indicators for business customers

 Profitability indicators

 The financial leverage factor as a barometer of a

business firm’s capital structure

Expense control measures

 Cost of goods sold/Net sales

 Selling, administrative and other expenses/Net sales

 Depreciation expenses/Net sales

 Interest expenses on borrowed funds /Net sales

 Taxes/Net sales

Operating efficiency

 Annual costs of goods sold/Average inventory

 Average receivables collection period

 Net sales/Net fixed assets

 Net sales/Total assets

 Net sales/Accounts receivables

Marketability of product or service

 Gross profit margin=(Net sales-CGS)/Net sales

 Net profit margin=Net income after taxes/Net sales

Coverage measures

 Interest coverage

 Coverage of interest and principal payments

Liquidity measures

 Current assets/Current liabilities

 Acid test ratio

 Working capital

 Net liquid assets

Profitability measures

 Before tax net income/Total assets

 After tax net income/Total assets

 Before tax net income/Net worth

 After tax net income/Net worth

Leverage or capital structure measures

Types of contingent liabilities

 Guarantees or warrantees behind products

 Litigation or pending lawsuits

 Unfunded pension liabilities

 Taxes owed but unpaid

 Limiting regulations

compensation and liability act

This law makes current and past owners of

contaminated property, current and past owners and prior operators of businesses located on contaminated property and those who transport hazardous

substances potentially liable.

Component of sources and uses of funds

statement

 Cash flows from operations

 Cash flows from investing activities

 Cash flows from financing activities

Traditional (direct) operating cash flows

Net sales revenue – Cost of goods sold – Selling,

general and administrative – Taxes paid in cash +

Non cash expenses

Indirect operating cash flows

Net income

+ Non cash expenses

+ Losses from the sale of assets

– Gains from the sale of assets

– Increases in assets associated with operations

+ Increases in current liabilities associated with operations – Decreases in current liabilities associated with operations + Decreases in current assets associated with operations

Methods used to price business loans

 Cost-plus loan pricing method

 Price leadership model

 Below prime market pricing

 Customer profitability analysis

Cost-plus loan pricing

Price leadership model

Prime rate

Major banks established a base lending fee during

the great depression At that time it was the lowest interest rate charged their most credit worthy

customers for short-term working capital loans.

LIBOR: London Interbank Offer Rate

The rate offered on short-term Eurodollar deposits

with maturities ranging from a few days to a few

months.

Below-prime market pricing

Customer profitability analysis (CPA)

 Estimate total revenues from loans and other

services

 Estimate total expenses from providing net loanable

funds

 Estimate net loanable funds

 Estimate before tax rate of return by dividing

revenues less expenses by net loanable funds

Questions & Problems

1 What special problems does business lending present to the

management of a business lending institution?

2 What are the essential differences among working capital loans,

open credit lines, asset-based loans, term loans, revolving credit lines, interim financing, project loans, and acquisition loans?

3 What are contingent liabilities, and why might they be important

in deciding whether to approve or disapprove a business loan request?

4 What are the principal strengths and weaknesses of the different

loan-pricing methods in use today?

5 Problem 3, 4, 6 and 7 (page 582-4)

AND PRICING BUSINESS

LOANS

Chapter 6