Chapter 13: Bank Management: A few selected answers to assigned end
of chapter questions
1. A bank's credit culture establishes actual lending principles. The bank’s credit “philosophy”
establishes the bank’s risk tolerance.
2. Business development and credit analysis evaluate the loan requests; the accept/reject
decision is made by “credit execution and administration.” Loans are then monitored by
“credit review” to determine whether risk and return objectives are met.
3.
The five C’s of credit?:
Character: Is the borrower a good person; are they honest?
Capital: Does the borrower have the resources to pay off the project if things “turn south”?
Capacity: Does the borrower have the legal standing and management expertise to handle the
loan?
Conditions: Are economic circumstances appropriate for this loan?
Collateral: What real estate, assets, cash flows or other unencumbered holdings does the
borrower have to support the loan, in the event of default ?
The 5 C's of bad credit include:
Complacency: Over-reliance on the past record of the borrower, despite other changing
circumstances.
Carelessness: Poor documentation or underwriting protocols (witness the “robo-signing”
fiascos of the foreclosure industry with the Great Recession).
Communication: Poor information flows between borrower, lender, and other stakeholders.
Contingencies: Tendency to ignore bad things (denial) might impact a loan's performance
Competition: Replicating competitor behavior without adhering to the bank's own credit
philosophies.
4. Credit risk management is forward looking: What is the likelihood of charge-offs in future
periods? Past charge-offs may reflect a different economic climate; borrowers also differ.
….past due loans are leading indicators of future charge-offs. Like bad tenants that get behind
on their rent, a disproportionate number of borrowers that get behind, stay behind, and
ultimately default.
5. The process of credit scoring involves using standardized information, such as financial
statement information and a borrower’s credit history, to mechanically evaluate a borrower’s
credit quality. It assigns a score to the data utilized. It does not require much human effort
other than to assess scores that do not clearly indicate accept or reject decisions. The net
effect is that the cost of handling a credit-scored loan, the loan administration expense, is
lower. Thus, a lender can earn the same or higher return on a credit-scored loan even when
losses are higher. The higher returns derive from the increased interest income charged the
lower-credit borrower, given his lower credit score. In the real estate arena, the apartment
complex may not charge the riskier tenant a higher rent, but that is a concept worthy of
reflection!!
6. Banks are in the business of getting monies at one cost of capital, investing it at a higher rate
of return (including fee income and after charge-offs and administrative expenses) and
“keeping the difference.” Typically, loans draw in other business from a customer. For
commercial accounts, this other business may be item processing, cash management, wire
transfers, etc. For consumer customers, this may be transactions accounts, other savings
vehicles, credit cards, safety deposit boxes, college accounts, mutual funds, trust services, etc.
7. Limitations on dividends, periodic provisions of financial data, asset management ratios and
growth limitations all serve to inform and protect the lender, as in the text book.
8. Perfecting a bank’s security interest simply entails filing suitable claims and documents (as
with keeping the title to a car, recording a mortgage or a judgment, having contracts on hand
describing the bank’s priority claims to inventory with a floor plan, having the wife’s jewels
being used as collateral in the bank’s vault, etc) to assure that chains of title and ownership
and such are arranged to secure the bank’s legitimate claims and to protect bank’s interests
according to the terms of the given loan. IN the most literal case, a perfection occurs when
the bank has physical possession of the collateral, but your professor is more generous in his
definitions! Perfection is achieved when the bank’s claim to collateral is evidenced as being
superior to all other claims.
9. Bank move loans off balance-sheet by selling loan participations to other lenders, and by
acting as loan brokers. As loan brokers, banks make loans but place them with other
investors, as with mortgage originators before the housing and financial crisis. Banks also
securitize loans by packaging standardized assets into pools and selling securities backed by
the promised loan payments. If this is done without recourse, the loans are taken off the
bank's books, justifiably. With recourse, a defaulting loan can again become the bank’s
obligation, even though it may have been moved off the bank’s balance sheet. Banks moved
problem loans off-balance sheet and were forced by the regulators and SEC in the mid to late2000’s (2008-2010) to move them back onto the bank’s financial statements thereby
increasing losses and the reported risk of the institution.
13. Loans can be readily securitized if they have standardized features that lenders or investors
can easily understand and if the loans have predictable default rates. Of the loans listed,
residential mortgages are the most easily securitized, followed by home equity loans,
credit card loans, and small business loans. Of the loans listed, only loans to farmers for
production purposes are difficult to securitize because each loan differs sharply across
borrowers.
14. Open credit lines: loans up to some pre-specified limit for a fixed period of time; returns
arise from fees and interest on actual borrowings; risk is that the borrower determines the
timing of takedowns, and this might occur when its financial condition has deteriorated. It
may also coincide with other borrowers taking down their lines such that the bank
experiences a sharp increase in liquidity needs.
Asset-based loans: loans secured by the borrower's assets, typically inventory and
receivables; returns in the form of fees and interest; risk is that the underlying assets do not
retain their value and may not exist.
Term commercial loans: long-term financing for the purchase of depreciable assets,
permanent working capital needs, or financing of mergers and acquisitions; returns in the
form of fees and interest on borrowing; risk is that the borrower's cash flow from operations
will be insufficient to meet the obligated payments.
Short-term real estate loans: loans with maturities under 1 year, secured by real estate;
income from fees and interest; risk is that tenants for the property might not appear, that the
real estate might decline in value, and that the borrower's cash flow is insufficient to meet the
payment obligations.
17. Consumer credit card lending has produced substantial profits for banks with large portfolios.
Many consumers are not rate sensitive (interest rates are said to be “sticky”) such that
consumer card loan rates are among the highest rates around. Defaults are also predictable if
the borrowing pool is large enough. Banks can charge fees and the cost of making these loans
has decreased, on average, with the advent of credit scoring, and with the vast electronic
platforms upon which credit card programs are marketed and managed.
Chapter 13 Sample Questions: Overview of Credit Policy and Loan Characteristics
1.
a.
b.
c.
d.
e.
According to the handout in class, commercial real estate loans in December of 2010 were the:
Most highly delinquent loans among commercial banks in the US.
Second most delinquent loans among commercial banks in the US.
Third most delinquent loans among commercial banks in the US.
Second least delinquent loans among commercial banks in the US.
Least delinquent loans among commercial banks in the US.
2.
a.
b.
c.
d.
e.
According to the handout in class, residential real estate loans in December of 2010 were the:
Most highly delinquent loans among commercial banks in the US.
Second most delinquent loans among commercial banks in the US.
Third most delinquent loans among commercial banks in the US.
Second least delinquent loans among commercial banks in the US.
Least delinquent loans among commercial banks in the US.
3.
a.
b.
c.
d.
e.
The largest single loan category for all banks is:
real estate loans.
commercial loans.
credit card loans.
industrial loans.
agricultural loans.
4.
a.
b.
c.
d.
e.
Banks that emphasize lending to individuals are labeled:
wholesale banks.
retail banks.
personal banks.
non-bank banks.
regional banks.
5.
a.
b.
c.
d.
e.
Banks that emphasize lending to commercial customers are labeled:
wholesale banks.
retail banks.
personal banks.
non-bank banks.
regional banks.
6.
a.
b.
c.
d.
e.
The vast majority of FDIC-insured institutions are classified as:
credit card banks.
agricultural banks.
consumer lenders.
commercial lenders.
mortgage lenders.
7.
a.
b.
c.
d.
e.
To be classified as a non-current loan, payments must be past due a minimum of how many days?
30 days
60 days
90 days
120 days
158 days
8.
a.
b.
c.
d.
e.
Which of the following formalizes a bank’s lending guidelines?
Loan policy
Credit culture
Credit analysis
Credit review
Loan documentation
9.
a.
b.
c.
d.
e.
Which of the following refers to the principles that drive a bank’s lending activity?
Loan policy
Credit culture
Credit analysis
Credit review
Loan documentation
10.
a.
b.
c.
d.
e.
Which of the following is the primary emphasis of a values-driven credit culture?
Annual bank profit
Bank soundness and stability
Loan volume
Loan growth
Short-term earnings
11.
a.
b.
c.
d.
e.
A security interest in a loan is said to be perfected if the:
The bank holds the collateral, such as the family jewels or a car’s title.
The loan has no protective covenants.
The borrower is a low credit risk, such as a national drub chain.
The government guarantees the loan.
The bank has never lent to the customer before.
12.
a.
b.
c.
d.
e.
Which of the following is not one of the five Cs of (good) credit?
Character
Collateral
Capital
Capacity
Credit
13.
a.
b.
c.
d.
e.
The ability to repay a loan is measured by a borrower’s:
capacity.
collateral.
character.
capital.
credit.
14.
a.
b.
c.
d.
e.
A secondary source of repayment, security “beneath” a loan, in the case of default is:
capacity.
character.
capital.
credit.
collateral.
15.
a.
b.
c.
d.
e.
Which of the following is not one of the five Cs of bad credit?
Complacency
Contingencies
Competition
Contention
Carelessness
16. Which of the following refers to a lender's tendency to ignore circumstances in which a loan
might default?
a. Complacency
b. Contention
c. Contingencies
d. Competition
e. Carelessness
17.
a.
b.
c.
d.
e.
Loan covenants:
protect the borrower from lender interference in management.
are limited to “negative” provisions.
may limit discretionary cash outlays by borrowers.
are seldom enforced.
often result in the lender’s bankruptcy.
18.
a.
b.
c.
d.
e.
When a bank’s claim to collateral is superior to all other creditors, the claim is said to be:
developed.
guaranteed.
certified.
perfected.
endorsed.
Use the following firm working capital cycle information for questions 19– 21.
Days Accruals
Days Cash
Days Inventory
Days Payables
Days Receivables
Average Daily COGS
11
6
26
17
31
22
19. What is the firm’s cash-to-cash asset cycle?
Asset cycle = Days Cash + Days Inventory + Days Receivables (63 Days)
20. What is the firm’s liability cycle?
Liability cycle = Days Payables + Days Accruals (28 Days)
21. What are the firm’s estimated working capital needs?
Working Capital Needs = (Asset Cycle – Liabilities Cycle) * Average Days COGS ($770)
22.
a.
b.
c.
d.
e.
Banks rarely provide:
start-up capital loans.
mortgage loans.
automobile loans.
agricultural loans..
commercial loans.
Use the following firm working capital cycle information for questions 23 – 25.
Days Accruals
Days Cash
Days Inventory
Days Payables
Days Receivables
Average Daily
COGS
8
7
32
26
30
18
23. What is the firm’s cash-to-cash asset cycle? (69 days)
24. What is the firm’s liability cycle? (34 days)
25. What are the firm’s estimated working capital needs? ($630)
26.
a.
b.
c.
d.
e.
A loan where the entire principal is due at maturity is called a:
balloon payment loan.
sinking fund loan.
mezzanine loan.
bullet loan.
highly leverage transaction loan.
(your text suggests d is the answer, but a fits perfectly with some real estate loans)
27. _______________________ represents the amount of long-term financing required for current
assets.
a. Permanent working capital
b. Seasonal working capital
c. Secondary working capital
d. Perpetual working capital
e. Passive working capital
28.
a.
b.
c.
d.
e.
A _______________________ is a post office box number controlled by the bank.
syndication
local
lockbox
maintenance box
microhedge
29.
a.
b.
c.
d.
e.
Venture capital financing that comes in the “later rounds” of financing may take the form of:
start-up capital loans.
mezzanine financing.
automobile financing.
seed money.
staff financing.
30. According to evidence shared in class, but not highlighted in the textbook, “start-up” capital over
the first few years of a firm’s life typically derives from the following sources, in the following
order:
a. Family and friends, angels, VC’s, banks
b. Angels, VC’s, family and friends, banks
c. VC’s, angels, family and friends, banks
d. Family and friends, banks, angels, VC’s
e. Family and friends, angels, banks, VC’s