Lecture 5 Credit Risk I (Individual Loan Risk).pdf - Lecture 5 Credit Risk I(Individual Loan Risk Overview of lecture topics • This lecture –

Lecture 5 Credit Risk I (Individual Loan Risk).pdf -...

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Lecture 5 Credit Risk I (Individual Loan Risk)
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Overview of lecture topics This lecture: introduces key considerations involved in the credit assessment process. examines different types of loans issued by FIs and the characteristics of commercial and industrial loans. discusses issues in loan pricing and the expected return from loans. learns different methods for assessing the credit quality of loans and discuss reasons for default.
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Credit Risk: Individual Loan Risk The promised cash flows from loans and securities held by FIs may not be paid in full. In the event of default, the FI earns zero interest on the assets and may lose all or part of the principle lent. Credit quality problems, in the worst case, can cause an FI to become insolvent or can result in a significant drain on capital and net worth, which adversely affects its growth prospects and ability to compete.
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Assets subject to defaults: CBA 2018
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Credit Losses at Australian Banks: 1980–2013
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Credit Losses and Australian Bank Profitability
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Types of Loan Commercial and industrial (C&I) loans Real estate loans Individual (consumer) loans such as personal or auto loans Other loans e.g. government loans, margin loans, farm loans
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Allocation of U.S. Bank Loans
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Nonperforming Asset Ratio for U.S. Commercial Banks
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Characteristics of C&I Loans Short-term or long-term Short-term loans: finance clients’ working capital needs and other short-term funding needs Long-term loans: finance clients’ purchase of real assets, new venture start-up costs and permanent increases in working capital Syndicated loans: Finance provided by a group of lenders as opposed to a single lender, usually to finance large C&I loans. A syndicated loan is structured by the lead FI (or agent) and the borrower. Once the terms are set, pieces of the loan are sold to other FIs. Secured or unsecured Secured loan (or asset-backed loan): backed by specific assets (collateral) of the borrower. If the borrower defaults, the lender has a first lien or claim on those assets. Unsecured debt: has only a general claim on the assets of the borrower if default occurs. It is junior to a secured loan.
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Commercial and Industrial Loans Spot loan or loan commitment (line of credit) Spot loan: the entire loan amount is taken down immediately Loan commitment: t he borrower has the option to take down up to a maximum amount of loan anytime over the commitment period. Fixed vs. Floating Rate Loans A fixed rate loan has the rate set at the beginning of the contract period. The rate remains in force over the loan contract period no matter what happens to market rates. The FI bears all the interest rate risk.
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