Ch_14_Com_Loan_Cr_risk

Ch_14_Com_Loan_Cr_risk - Evaluating Commercial Loan...

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Evaluating Commercial Loan Requests and Managing Credit Risk 11
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Evaluating Commercial Loan n Important Questions Regarding Commercial Loan Requests 1. What is the character of the borrower and quality of information provided? 2. What are the loan proceeds going to be used for? 3. How much does the customer need to borrow? 4. What is the primary source of repayment, and when will the loan be 22
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Fundamental Credit Issues n There are two types of loan errors n Type I Error n Making a loan to a customer who will ultimately default n Type II Error n Denying a loan to a customer who would ultimately repay the debt 33
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Fundamental Credit Issues n Character of the Borrower and Quality of Data Provided n The most important issue in assessing credit risk is determining a borrower’s commitment and ability to repay debts in accordance with the terms of a loan agreement n The best indicators are the borrower’s financial history and personal references 44
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Fundamental Credit Issues n Character of the Borrower and Quality of Data Provided n Audited financial statements are preferred in determining the quality of the data because accounting rules are well established so that an analyst can better understand the underlying factors that affect the entries n But just because a company has audited financial statements, however, does not mean the reported data are 55
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Fundamental Credit Issues n Use of Loan Proceeds n Loan proceeds should be used for legitimate business operating purposes, including seasonal and permanent working capital needs, the purchase of depreciable assets, physical plant expansion, acquisition of other firms, and extraordinary operating expenses n Speculative asset purchases and debt substitutions should be avoided 66
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Fundamental Credit Issues n How Much Does the Borrower Need? The Loan Amount n Borrowers often request a loan before they clearly understand how much external financing is actually needed and how much is available internally n The amount of credit required depends on the use of the proceeds and the availability of internal sources of funds 77
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Fundamental Credit Issues n How Much Does the Borrower Need? The Loan Amount n For a shorter-term loan, the amount might equal the temporary seasonal increase in receivables and inventory net of that supported by increased accounts payable n With term loans, the amount can be determined via pro forma analysis which is the projecting or forecasting of a company’s financial statements 88
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Fundamental Credit Issues n The Primary Source and Timing of Repayment n Loans are repaid from cash flows: n Liquidation of assets n Cash flow from normal operations n New debt issues n New equity issues 99
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Fundamental Credit Issues n The Primary Source and Timing of Repayment n Specific sources of cash are generally associated with certain types of loans n Short-term, seasonal working capital loans are normally repaid from the liquidation of receivables or reductions in inventory 1010
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This note was uploaded on 09/07/2011 for the course FIN 653 taught by Professor Cobus during the Spring '08 term at S.F. State.

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Ch_14_Com_Loan_Cr_risk - Evaluating Commercial Loan...

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