CHAPTER SIXTEEN Lending To Business Firms And Pricing Business Loans The purpose of this chapter is...
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![Page 1: CHAPTER SIXTEEN Lending To Business Firms And Pricing Business Loans The purpose of this chapter is to explore how bankers can respond to a business customer.](https://reader030.fdocuments.us/reader030/viewer/2022033104/56649d8d5503460f94a74adf/html5/thumbnails/1.jpg)
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CHAPTER SIXTEENLending To Business Firms And Pricing Business Loans
The purpose of this chapter is to explore how bankers can respond to a business customer seeking a loan and to reveal the factors they must consider in evaluating a business loan request. In addition, we explore the different methods used today to price business loans and to evaluate the strengths and weaknesses of these pricing methods for achieving a financial institution’s goals.
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Short Term Business Loans
Self-Liquidating Inventory Loans
Working Capital Loans
Interim Construction Loans
Security Dealer Financing
Retailer Financing
Asset-Based Financing
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Syndicated Loans
A Loan or Line of Credit Extended to a Business Firm By a Group of Lenders in Order to Reduce the Risk Exposure to Any One Lending Institution
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Long Term Business Loans
Term Loans
Revolving Credit Lines
Project Loans
Loans to Support Acquisitions of Other Business Firms
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Sources of Repayment for Business Loans
The Borrower’s Profits or Cash Flows
Business Assets Pledged as Collateral
Strong Balance Sheet With Ample Marketable Assets and Net Worth
Guarantees Given By Businesses
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Analyzing Business Loan Applications
Common Size Ratios of Customer Over Time
Financial Ratio Analysis of Customer’s Financial Statements
Current and Pro Forma Sources and Uses of Funds Statement
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Financial Ratio Analysis
Control Over Expenses
Operating Efficiency
Marketability of Product or Service
Coverage Ratios: Measuring Adequacy of Earnings
Liquidity Indicators for Business Customers
Profitability Indicators
The Financial Leverage Factor as a Barometer of a Business firm’s Capital Structure
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Control Over Expenses
Wages and Salaries/Net Sales
Overhead Expenses/Net Sales
Depreciation Expenses/Net Sales
Interest Expense on Borrowed Funds/Net Sales
Cost of Goods Sold/Net Sales
Selling, Administrative and Other Expenses/Net Sales
Taxes/Net Sales
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Operating Efficiency
Costs of Goods Sold/Average Inventory
Net Sales/Total Assets
Net Sales/Fixed Assets
Net Sales/Accounts Receivables
Accounts Receivables/(Net Sales/360)
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Marketability of Product or Service
(Net Sales – Cost of Goods Sold)/Net Sales
Net Income After Taxes/Net Sales
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Coverage
Income Before Interest and Taxes Interest Payments
Income Before Interest and Taxes Interest Pay. + Princ. Pay/(1-Marg.Tax)
Income Before Interest, Taxes and Lease Payments Interest Payments + Lease Payments
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Liquidity
Current Assets Current Liabilities
Current Assets – Inventory Current Liabilities
Current Assets – Inventory (raw) –Current Liabilities
Current Assets – Current Liabilities
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Profitability
Before Tax Net Income/Total Assets
Before Tax Net Income/Net Worth
Before Tax Net Income/Total Sales
After Tax Net Income/Total Assets
After Tax Net Income/Net Worth
After Tax Net Income/Total Sales
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Leverage
Total Liabilities Total Assets
Long Term Debt (LTD) Total LTD + Net Worth
Total Liabilities Net Sales
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Types of Contingent Liabilities
Guarantees or Warrantees Behind Products
Litigation or Pending Lawsuits
Unfunded Pension Liabilities
Taxes Owed But Unpaid
Limiting Regulations
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Comprehensive Environmental Response, Compensation and Liability
Act
This Law Makes Current and Past Owners of Contaminated Property, Current and Past Owners and Prior Operators of Businesses Located on Contaminated Property and Those Who Transport Hazardous Substances Potentially Liable
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Component of Sources and Uses of Funds Statement
Changes in Cash Account
Changes in Accounts Receivables
Changes in Inventory
Changes in Fixed Assets
Changes in Accounts PayableChanges in Other Current LiabilitiesChanges in Long Term DebtChanges in Net Worth
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Sources and Uses of Funds
Increase in Assets = Use of Funds
Decrease in Assets = Source of Funds
Increase in Liabilities = Source of Funds
Decrease in Liabilities = Use of Funds
Increase in Equity = Source of Funds
Decrease in Equity = Use of Funds
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Methods Used to Price Business Loans
Cost-Plus Pricing ModelsPrice Leadership Pricing ModelsBelow Prime Market Pricing (Markup Model)Loans Bearing Maximum Interest RatesCustomer Profitability Analysis
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Cost-Plus Loan Pricing
Loan Interest
Rate=
Marginal Cost of Raising
Loanable Funds to Lend to
Borrower
+
Nonfund Bank
Operating Costs
+
Estimated Margin to
Compensate Bank for
Default Risk
+
Bank's Desired Profit
Margin
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Price Leadership Model
Loan Interest
Rate=
Base or Prime Rate
+
Default Risk
Premium for Non-
Prime Borrowers
+
Term Risk Premium for
Longer Term Credit
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Prime Rate
Major Banks Established a Base Lending Fee During the Great Depression. At that Time It Was the Lowest Interest Rate Charged Their Most Credit Worthy Customers for Short-Term Working Capital Loans
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
LIBOR
The London Interbank Offer Rate. The Rate Offered on Short-Term Eurodollar Deposits With Maturities Ranging From a Few Days to a Few Months
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Below-Prime Market Pricing
Loan Interest
Rate=
Interest Cost of Borrowing in the Money
Market
+Markup for Risk
and Profit
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Cap Rate Model
Banks Offer a Floating Rate Loan With an Agreed Upon Upper Limit on the Loan Contract Regardless of the Course of Future Interest Rates
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McGraw-Hill/IrwinBank Management and Financial Services, 6/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
Customer Profitability Analysis (CPA)
Estimate Total Revenues From Loans and Other ServicesEstimate Total Expenses From Providing Net Loanable FundsEstimate Net Loanable FundsEstimate Before Tax Rate of Return By Dividing Revenues Less Expenses By Net Loanable Funds