468-20 - Chapter 20 - CREDIT RISK FIs special role: Ability...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 20 - CREDIT RISK FI’s special role: Ability to: 1) Evaluate information and 2) Control and monitor borrowers. Allows FI's to transform financial claims of household/savers efficiently into claims (debt and equity) issued to corporations, individuals, and governments, at the lowest possible cost to all parties, a process of Financial Intermediation. FI accepts credit risk, in exchange for a fair return, sufficient to cover the cost of funding (e.g., covering the cost of borrowing, or issuing deposits) and a competitive profit margin. See Figure 20-1, p. 555: Nonperforming Loans/Total Asset ratio. Trend: General Improvement during 1990s. See Table 20-1, p. 556: Nonperforming Loans/Total LOANS. For loans to individuals, higher default rate for large banks (1.50-1.65%) than small banks (.80-1.01%). Reason: Large banks more willing to accept higher risk. See example page 558, adjustment of balance sheet to loan loss, credit quality problem. CREDIT ANALYSIS 1. Real Estate Lending - Residential mortgage loan applications are among the most standardized of all credit applications. Reason? Two considerations for Mortgages: a) Applicant’s ability and willingness to make timely interest and principal repayments - credit and savings history, income level and stability, stability of residence, age, monthly expenditures (car loans, student loans, credit card debt, etc.). Ratios used: GDS (Gross Debt Service) Ratio - Annual Housing Expenses (Mortgage + Condominium or management fees, Property taxes, Insurance, etc.) divided by Annual Gross Income. Should be less than 25-30%. (Approx. $2,000 to $2,500 per month for $100,000 annual income) TDS (Total Debt Service) Ratio - Total Annual Debt (housing, car, student loans, credit cards, etc.) expenses divided by gross annual income. Should be 35-40% or less. ($3,000 to $3,333 per month for $100,000 income) See Example 20-1 on p. 559. Credit Scoring System - Mathematical model that uses observed loan applicant’s characteristics to calculate a single, numerical value that represents the applicant’s probability of default. Easy to use, convenient, low cost. See Example 20-2 on p. 560-561. Score < 120 automatically rejected, Score > 190 automatically accepted. Scores between 120-190 are reviewed by committee. BUS 468 / MGT 568: FINANCIAL MARKETS - CH 20 Professor Mark J. Perry 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
b) After/if loan approved, next issue: Value of collateral/real estate. Issues: Clear legal title (no claims), property survey, property taxes current, and appraisal. Foreclosure: Process of taking possession of property if the case of default. 2. Consumer and Small-Business Lending . a) Techniques for scoring consumer loans very similar to mortgage loan credit analysis but more emphasis placed on personal characteristics such as annual gross income and the TDS score. b) Small-business loans more complicated, requiring FIs to build more sophisticated scoring models
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 01/24/2012 for the course MGT 568 taught by Professor Staff during the Spring '11 term at University of Michigan.

Page1 / 6

468-20 - Chapter 20 - CREDIT RISK FIs special role: Ability...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online