Chpater 17: Commercial Bank Management Key Topics

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CHAPTER 17

LENDING TO BUSINESS FIRMS AND PRICING BUSINESS LOANS

Goal of This Chapter: 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.

Key Topics in This Chapter

• Types of Business Loans: Short-Term and Long-Term • Analyzing Business Loan Requests
• Collateral and Contingent Liabilities
• Sources and Uses of Business Funds
• Pricing Business Loans
• Customer Profitability Analysis

Chapter Outline

I. Introduction
II. Brief History of Business Lending
III. Types of Business Loans
IV. Short-Term Loans to Business Firms
A. Self-Liquidating Inventory Loans
B. Working Capital Loans
C. Interim Construction Financing
D. Security Dealer Financing
E. Retailer and Equipment Financing
F. Asset-Based Financing
G. Syndicated Loans (SNCs)
V. Long-Term Loans to Business Firms
A. Term Business Loans
B. Revolving Credit Financing
C. Long-Term Project Loans
D. Loans to Support the Acquisition of Other Business Firms-Leveraged Buyouts VI. Analyzing Business Loan Applications
A. Most Common Sources of Loan Repayment
B. Analysis of a Business Borrower's Financial Statements VII Financial Ratio Analysis of a Customer's Financial Statements A. The Business Customer's Control over Expenses
B. Operating Efficiency: Measure of a Business Firm's Performance Effectiveness C. Marketability of the Customer's Product or Service
D. Coverage Ratios: Measuring the Adequacy of Earnings E. Liquidity Indicators for Business Customers
F. Profitability Indicators
G. The Financial Leverage Factor as a Barometer of a Business Firm's Capital Structure VIII Comparing a Business Customer’s performance to the Performance of Its Industry A. Contingent Liabilities

B. Environmental Liabilities
C. Underfunded Pension Liabilities
IX. Preparing Statements of Cash Flows from Business Financial Statements A. Cash Flow Statements
B. Pro Forma Statements of Cash Flow and Balance Sheets C. The Loan Officer's Responsibility to the Lending Institution and the Customer X. Pricing Business Loans
A. The Cost-Plus Loan pricing Method
B. The Price Leadership Model
C. Below-Prime Market Pricing
D. Customer Profitability Analysis (CPA)
1. An Example of Annualized Customer profitability Analysis 2. Earnings Credits for Customer Deposits
3. The Future of Customer Profitability Analysis XI. Summary of the Chapter

Concept Checks

17-1.What special problems does business lending present to the management of a business lending institution?

While business loans are usually considered among the safest types of lending (their default rate, for example, is usually well below default rates on most other types of loans), these loans average much larger in dollar volume than other loans and, therefore, can subject an institution to excessive risk of loss and, if a substantial number of loans fail, can lead to failure. Moreover, business loans are usually much more complex financial deals than most other kinds of loans, requiring larger numbers of personnel with special skills and knowledge. These additional resources required increase the magnitude of potential losses unless the business loan portfolio is managed with great care and skill.

17-2.What are the essential differences among working capital loans, open credit lines, asset-based loans, term loans, revolving credit lines, interim...
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