Problems for Commercial Bank Management
Lecture 2
2.1
From the descriptions below please identify what type of business loan is
involved.
a. A temporary credit supports construction of homes, apartments, office buildings,
and other permanent structures.
b. A loan is made to an automobile dealer to support the shipment of new cars.
c. Credit extended on the basis of a business’s accounts receivable.
d. The term of an inventory loan is being set to match the length of time needed to
generate cash to repay the loan.
e. Credit extended up to one year to purchase raw materials and cover a seasonal need
for cash.
f. A security dealer requires credit to add new government bonds to his security
portfolio.
g. Credit granted for more than a year to support purchases of plant and equipment.
h. A group of investors wishes to take over a firm using mainly debt financing.
i. A business firm receives a three-year line of credit against which it can borrow,
repay, and borrow again if necessary during the loan’s term.
j. Credit extended to support the construction of a toll road.
2.2 From the data given in the following table, please construct as many of the
financial ratios discussed in this chapter as you can and then indicate the dimension of
a business firm’s performance each ratio represents.
Business Assets
Cash account
Accounts receivable
Inventories
Fixed assets
Miscellaneous assets
Liabilities and Equity
Short-term debt:
Accounts payable
Notes payable
Long-term debt (bonds)
Miscellaneous liabilities
Equity capital
50
155
128
286
96
715
108
107*
325*
15
160
715
Annual Revenue and Expense Items
Net sales
Cost of goods sold
Wages and salaries
Interest expense
Overhead expenses
Depreciation expenses
Selling, administrative,
and other expenses
Before-tax net income
Taxes owed
After-tax net income
650
485
58
28
29
12
28
10
3
7
* Annual principal payments on bonds and notes payable total $55. The firm’s
marginal tax rate is 35 percent.
1
2.3
Pecon Corporation has placed a term loan request with its lender and submitted
the following balance sheet entries for the year just concluded and the pro forma
balance sheet expected by the end of the current year. Construct a pro forma
Statement of Cash Flows for the current year using the consecutive balance sheets and
some additional needed information. The forecast net income for the current year is
$225 million with $50 million being paid out in dividends. The depreciation expense
for the year will be $100 million and planned expansions will require the acquisition
of $300 million in fixed assets at the end of the current year. As you examine the pro
forma Statement of Cash Flows, do you detect any changes that might be of concern
either to the lender’s credit analyst, loan officer, or both?
Pecon Corporation
(all amounts in millions of dollars)
Asstes at
the End of
the Most
Recent
Year
Cash
$
532
Accounts receivable
1,018
Inventories
894
Net fixed assets
Other assets
Total assets
Assets
Projected
for the End
of the
Curreny
Year
$
624 Accounts payable
1,210 Notes payable
973 Taxes payable
2,740
66
$
5,250
$
Liabilities
and Equity
at the End
of the most
recent Year
$
970
2,733
327
2,940 Long-term debt obligations
87 Common stock
Undivided profits
5,834 Total liabilities and equity capital $
872
85
263
5,250
2.4
As a loan officer for Sun Flower National Bank, you have been responsible for
the bank’s relationship with USF Corporation, a major producer of remote-control
devices for activating television sets, DVDs, and another audio-video equipment. USF
has just filed a request for renewal of its $10 million line of credit, which will cover
approximately nine months. USF also regularly uses several other services sold by the
bank. Applying customer profitability analysis (CPA) and using the most recent year
as a guide, you estimate that the expected revenues from this commercial loan
customer and the expected costs of serving this customer will consist of the following:
2
Liabilities
and Equity
for the End
of the
Current
Year
$ 1,279
2,950
216
$
931
85
373
5,834
Expected Revenues
Expected Costs
Interest income from the
requested loan (assuming an
annualized loan rate of 4%
for 9 months)
Loan commitment fee (1%)
Deposit management fees
Wire transfer fees
Fees for agency services
Interest paid on customer
deposits (3.5%)
Cost of other funds raised
Account activity costs
Wire transfer costs
Loan processing costs
Recordkeeping costs
—?
100,000
4,500
3,500
4,500
—?
180,000
5,000
1,300
12,400
4,500
The bank’s credit analysts estimated the customer probably will keep an
average deposit balance of $2,125,000 for the year the line is active. What is the
expected net rate of return from this proposed loan renewal if the customer actually
draws down the full amount of the requested line for nine months? What decision
should the bank make under the foregoing assumptions? If you decide to turn down
this request, under what assumptions regarding revenues, expenses, and customer
deposit balances would you be willing to make this loan?
2.5
In order to help fund a loan request of $10 million for one year from one of its
best customers, Lone Star Bank sold negotiable CDs to its business customers in the
amount of $6 million at a promised annual yield of 3.50 percent and borrowed $4
million in the Federal funds market from other banks at today’s prevailing interest rate
of 3.25 percent.
Credit investigation and recordkeeping costs to process this loan application
were an estimated $25,000. The Credit Analysis Division recommends a minimal 1
percent risk premium on this loan and a minimal profit margin of one-fourth of a
percentage point. The bank prefers using cost-plus loan pricing in this case. What loan
rate would it charge?
Lecture 3
3.1
Mr. and Mrs. Napper are interested in funding their children's college education
by taking out a home equity loan in the amount of $24,000. Eldridge National Bank is
willing to extend a loan, using the Napper's home as collateral. Their home has been
appraised at $110,000, and Eldridge permits a customer to use no more than 70
percent of the appraised value of the home as a borrowing base. The Nappers still owe
$60,000 on the first mortgage against their home. Is there enough residual value left
in the Nappers’ home to support their loan request? How could the lender help them
meet their credit needs?
3.2
Ben James has just been informed by a finance company that he can access a
line of credit of no more than $75,000 based upon the equity value in his home.
James still owes $125,000 on a first mortgage against his home and $25,000 on a
second mortgage claim against the home, which was incurred last year to repair the
3
roof and driveway. If the appraised value of James’s residence is $300,000, what
percentage of the home's estimated market value is the lender using to determine
James’s maximum available line of credit?
3.3
Jamestown Savings Bank, in renewing its credit card customers finds that of
those customers scoring 40 points or less on its credit-scoring system, 35 percent (or a
total of 10,615 credit customers) turned out to be delinquent credits resulting in total
losses. This group of bad credit card loans averaged $6,800 in size per customer
account. Examining its successful credit accounts Jamestown finds that 12% of its
good customers (or a total of 3,640 customers) scored 40 points or less on the bank’s
scoring system. These low scoring but good accounts generated about $1,700 in
revenues each. If Jamestown’s credit card division follows the decision rule of
granting credit cards only to those customers scoring more than 40 points and future
credit accounts generate about the same average revenues and losses, about how much
can the bank expect to save in net losses.
3.4
The Lathrop family needs some extra funds to put their two children through
college starting this coming fall and to buy a new computer system for a part-time
home business. They are not sure of the current market value of their home, though
comparable 4-bedroom homes are selling for about $410,000 in the neighborhood.
The Monarch University Credit Union will loan 75 percent of the property’s appraised
value, but the Lathrops still owe $265,000 on their home mortgage and home
improvement loan combined. What maximum amount of credit is available to this
family should it elect to seek a home equity credit line?
3.5
The Crockett family has asked for a 30-year mortgage in the amount of
$325,000 to purchase a home. At a 7 percent loan rate, what is the required monthly
payment?
3.6
The Watson family has been planning a vacation to Europe for the past two
years. Gratton Savings agrees to advance a loan of $7,200 to finance the trip provided
the Watsons pay the loan back in 12 equals monthly installments. Gratton will charge
an add-on loan rate of 6%. How much in interest will the Watsons pay under the addon loan rate method? What is the amount of each required monthly payment? What
is the effective loan rate in this case?
3.7
Jane Zahrley’s request for a four-year automobile loan for $33,000 has been
approved. Reston Center Bank will require equal monthly installment payments for
48 months. The bank tells Jane that she must pay a total of $5,500 in finance charges.
What is the loan’s APR?
3.8
Mary Cantrary is offered a $1,600 loan for a year to be paid back in equal
quarterly installments of $400 each. If Mary is offered the loan at 8 percent simple
interest, how much in total interest charges will she pay? Would Mary be better off
(in terms of lower interest cost) if she were offered the $1,600 at 6 percent simple
4
interest with only one principal payment when the loan reaches maturity? What
advantage would this second set of loan terms have over the first set of loan terms?
Lecture 5
5.1
Suppose that a bank is expected to pay an annual dividend of $4 per share on its stock
in the current period and dividends are expected to grow 5 percent a year every year, and the
minimum required return-to-equity capital based on the bank's perceived level of risk is 10
percent. Can you estimate the current value of the bank's stock?
5.2
Suppose a banker tells you that his bank in the year just completed had total interest
expenses on all borrowings of $12 million and noninterest expenses of $5 million, while
interest income from earning assets totaled $16 million and noninterest revenues totaled $2
million.
Suppose further that assets amounted to $480 million, of which earning assets represented 85
percent of that total while total interest-bearing liabilities amounted to 75 percent of total
assets. See if you can determine this bank's net interest and noninterest margins and its
earnings base and earnings spread for the most recent year.
5.3
Suppose a bank has an ROA of 0.80 percent and an equity multiplier of 12X. What is
its ROE? Suppose this bank's ROA falls to 0.60 percent. What size equity multiplier must it
have to hold its ROE unchanged?
5.4
Paintbrush Valley State Bank has just submitted its Report of Condition and Report of
Income to its principal supervisory agency. The bank reported net income before taxes and
securities transactions of $37 million and taxes of $8 million. If its total operating revenues
were $950 million, its total assets $2.7 billion, and its equity capital $250 million, determine
the following for Paintbrush Valley:
a. Tax management efficiency ratio.
b. Expense control efficiency ratio.
c. Asset management efficiency ratio.
d. Funds management efficiency ratio.
e. ROE.
5.5
Using this information for Eagle Bank and Trust Company (all figures in millions),
calculate the bank's net interest margin, noninterest margin, and ROA.
Interest income
Interest expense
Provision for loan losses
Security gains (or losses)
Noninterest expense
Noninterest income
Extraordinary net gains
Total assets
$
75
61
6
2
8
5
1
1,000
5