SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet 2

SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet...

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Unformatted text preview: 3/17/11 11 Base Lending Rate The base lending rate is the minimum interest rate that a bank uses to price, or establish the interest rates (APRs) on its various loans the base lending rate reflects current and expected economic and financial market conditions (including the banks cost of funds) 3/17/11 Base Lending Rate Historically on fixed rate loans, the base lending rate is most often the prime rate. More recently, LIBOR has become more popular. The prime rate has recently been closely tied to the Fed Funds Rate which is an administered rate (the Feds target rate) Thus the Prime Rate does not capture contemporaneous changes in current market conditions Ten year average for LIBOR is 4.76% (current LIBOR ranges from .24% to 1.09%) Prime is 7.42% (current Prime Rate is 3.25%) That represents a spread of approx. 2.66% bankrate.com 22 3/17/11 Base Lending Rate On variable rate loans the base rate is often either LIBOR [London Inter-Bank Offer Rate] the Prime Rate a CD rate or Money Market Rate On mortgage loans (real estate loans) the base rate is often the 10-year Treasury Note rate or the FHLB 11th District Cost of Funds Index Weighted average of the cost of borrowing funds from the FHLB 33 3/17/11 Base Lending Rate Typically lenders price loans by adding a premium (credit spread) to two base rates Example Rate on Mid-Market commercial loan APR = LIBOR + 200 to 300 bp APR = PRIME + 50 to 150 bp APR denotes Annual Percentage Rate Note: Lenders are NOW also starting to 44 3/17/11 Risk Ratings Example: 55 Most banks have a ratings system that includes measures of risk (PD) LGD This will allow them to determine the loans expected loss rate. 3/17/11 66 Rating (PD) Definition Guidance 1 Borrower of Highest Quality S&P AAA & AA 2 Borrower of Superior Quality S&P AA & A 3 Borrower of Exceptional Quality S&P A 4 Borrower of Excellent Quality S&P BBB+ & BBB 5 Borrower of Strong Quality S&P BBB & BBB- 6 Borrower of Good Quality...
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SC3-Chapter 20 - Managing Credit Risk on the Balance Sheet...

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