CHAPTER 12
CONSUMER AND SMALL
BUSINESS LENDING
Chapter 12
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LEARNING OBJECTIVES
TO UNDERSTAND…
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The markets for and importance of small-business
lending, consumer installment lending, residential
mortgages, and home-equity lines of credit
The credit analysis, pricing, and risks of smallbusiness, consumer, and residential-mortgage lending
Credit scoring for consumers and small businesses
and how it can be misused
The importance and growth of subprime lending and
the outcry about “predatory practices” and attempts
to regulate them
The future of consumer and small-business lending
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Overview of Consumer
Lending
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At year-end 1985, commercial banks held total
consumer loans of $284b, at the beginning of 2000,
the figure was $558b (compound annual growth of
5%).
Credit-card loans grew from $68b year-end 1985 to
$212b at the beginning of 2000 (compound annual
growth of 8.5%).
Since year-end 1988, home-equity loans held by all
commercial banks have grown from $35b to $98b at
the beginning of 2000 (compound annual growth of
9.8%).
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The Role of TRICK
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Transparency/disclosure/predatory
practices have become major issues in
subprime lending
Risk exposure of subprime lending has
got the attention of the market and
regulators
Information technology (credit scoring)
plays a major in retail lending
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The Role of TRICK (continued)
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Competition for customers has
intensified especially for consumers and
small businesses
Capital adequacy always is an issue in
banking and has surfaced with respect
to subprime lending
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Securitization
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Started with government-sponsored
enterprises (GSEs such as Ginnie Mae,
Fannie Mae, and Freddie Mac) and the
residential-mortgage market
Trickled down to credit cards and auto
loans
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The Characteristics of
Small Businesses
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500 employees of less => “small”, however,
two-thirds of small businesses have fewer
than five employees
Location: 80% in urban areas
SIC description
Retail trade
Business services
Professional services
Construction/mining
All others
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Percent
21.7
21.2
16.6
14.2
26.3
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Financial Services Used
by Small Businesses
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Three broad categories of services
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Liquid-asset accounts
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Checking and savings
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Credit lines, loans, and capital leases
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Financial-management services
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Cash management, brokerage, trust, pension
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The Suppliers
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Depository institutions
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Nondepository institutions
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Table 12-3 (p. 397) shows that commercial banks
dominate as suppliers of financial services to small
businesses
Finance company, brokerage, leasing
Nonfinancial
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Family, individual, other businesses, government
(SBA)
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Credit Analysis and Credit
Scoring
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Evolution from the 5Cs to credit scoring for
consumers
Small businesses stand on the far left-hand
side of the borrower-information continuum
(Ch. 10) – scare information that is costly to
obtain
Fewer than five employees => 5Cs approach
might be best, especially character
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Credit Scoring: Understanding
FICO (Box 12-1, p. 400)
Fair, Isaac & Co. is a risk-management
company that have developed a creditscoring system referred to as FICO.
A FICO score is based on information found
within your credit report. The 5 basic
categories of importance:
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1.
2.
3.
4.
5.
Payment History
Outstanding Debt
Credit History
Pursuit of New Credit
Types of Credit in Use
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Credit Scoring and DecisionMaking
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Figure 12-1 (p. 401) illustrates the
trade-off at origination between credit
score and the loan-to-value (LTV) ratio
Don’t short change the importance of
human judgment
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Consumer Lending
Loan category
2000 (growth)*
Residential mortgages
$ 839B (12.2%)
Installment loans
$ 346B ( 3.0%)
Credit-card loans
$ 212B (10.2%)
Home-equity loans
$ 98B (13.4%)
Total
$1,495B ( 9.8%)
*Amount at the beginning of 2000 and growth
rates since 1985 (1988 for home equity)
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Consumer Installment Credit:
Market Share and Types of Loans
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Types: Revolving (credit cards) and
nonrevolving
Holders/Suppliers
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Commercial banks
Finance companies
Credit unions
Savings institutions
Nonfinancial business (GE, GMAC)
Pools of securitized assets
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The Cost of Making Consumer
Loans (functional cost analysis)
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Cost categories
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Office space
Supplies
Services
Labor
Tables 12-9, 12-10, 12-11 (pp. 408410) present FCA data
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Credit Analysis For
Consumer Lending
Five stages in the analysis of new customers:
1.
Initial contact or introduction,
2.
Credit application,
3.
Review of the application,
4.
Credit analysis or evaluation, and
5.
Monitoring and control
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CAMPARI
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An alternative to the five Cs of credit analysis is CAMPARI.
In contrast to the five Cs, the CAMPARI framework is more
specific with respect to the purpose and terms:
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Character – the first of the five Cs
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Ability – in managing financial affairs
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Margin – interest rate, commission, and fees
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Purpose – of the loan
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Amount – of the loan
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Repayment – probability of
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Insurance – the collateral component of the five Cs
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A System Approach Versus
Individual Appraisal
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Credit-scoring systems have been in use
for years
Examples of variables
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Years on job
Home phone
Years at address
Major credit card
Credit bureau information
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Predicting Personal
Bankruptcy
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Research frameworks similar to those
used in predicting corporate bankruptcy
(classification models, Ch. 11)
Three national credit bureaus predict
personal bankruptcies
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Equifax
Trans Union
TRW
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Residential Real-Estate Lending: Mortgages and
Home-Equity Lines of Credit
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One of the biggest changes in bank
consumer lending has resulted from the
restructuring of the savings-and-loan
industry.
At the end of 1985, all commercial banks
held $188b in loans backed by one-to-four
family residential property. In 1999, it was
$767b or annual growth of 10.6%.
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Growth
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Residential mtgs
Bank size Growth*
Small
4.9%
Medium 11.5%
Large
14.4%
Top ten 12.9%
All banks 10.4%
*1985-1999
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Home-equity loans
Bank size Growth*
Small
-1.5%
Medium
-4.3%
Large
6.8%
Top ten 17.5%
All banks 5.4%
*1994-1999
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The Restructuring of
Residential Lending
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Fragmentation of the mortgage-lending
process (securitization steps)
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Origination
Funding/underwriting
Selling
Servicing
Investor
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Subprime Lending
Subprime portfolios are those made up of
loans to borrowers with higher-risk
characteristics defined to include:
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A FICO score of 660 or lower
Two or more 30-day delinquencies in the past
year
Bankruptcy in the last five years
A debt-to-income ratio of 50% or higher
A foreclosure, repossession, or charge-off in the
preceding 24 months
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Myths About
Subprime Lending
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Myth #1: Subprime lending has been responsible for
record homeownership rates among minorities and
lower-income groups
Myth #2: By and large, subprime lending is priced
efficiently
Myth #3: Proposed legislation is counterproductive
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The Future of Consumer and
Small-Business Lending
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Forces shaping the future
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Regulation (Table 12-17, p. 423)
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Interest-rate controls cause distortions (Figure
12-3, p. 422)
New sources of fee and choice
Automation and securitization
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Consumer Banking
Innovations
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Credit and debit cards
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ATMs that permit cash advances (loans)
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Systems approaches to lending
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Home-equity loans
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On-line banking
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CHAPTER SUMMARY
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Consumer and small-business lending
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Installment loans (credit cards)
Residential mortgages
Home-equity lines of credit
Loans and financial services for small
businesses
Credit scoring and securitization
Subprime lending
Chapter 12
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