1. CONSUMER AND SMALL BUSINESS LENDING
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CONSUMER AND SMALL BUSINESS LENDING
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2. LEARNING OBJECTIVES TO UNDERSTAND…
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 small-business, 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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3. Overview of Consumer Lending
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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4. The Role of TRICK
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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5. The Role of TRICK (continued)
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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6. Securitization
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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7. The Characteristics of Small Businesses
500 employees of less => “small”, however, two-thirds of small businesses have fewer than five employees
Location: 80% in urban areas
SIC description Percent
Retail trade
Business services
Professional services 16.6
Construction/mining
All others
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8. Financial Services Used by Small Businesses
Three broad categories of services
Liquid-asset accounts
Checking and savings
Credit lines, loans, and capital leases
Financial-management services
Cash management, brokerage, trust, pension
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9. The Suppliers Depository institutions Nondepository institutions
Table 12-3 (p. 397) shows that commercial banks dominate as suppliers of financial services to small businesses
Nondepository institutions
Finance company, brokerage, leasing
Nonfinancial
Family, individual, other businesses, government (SBA)
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10. Credit Analysis and Credit Scoring
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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11. Credit Scoring: Understanding FICO (Box 12-1, p. 400)
Fair, Isaac & Co. is a risk-management company that have developed a credit-scoring system referred to as FICO.
A FICO score is based on information found within your credit report. The 5 basic categories of importance:
Payment History
Outstanding Debt
Credit History
Pursuit of New Credit
Types of Credit in Use
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12. Credit Scoring and Decision-Making
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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13. 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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14. Consumer Installment Credit: Market Share and Types of Loans
Types: Revolving (credit cards) and nonrevolving
Holders/Suppliers
Commercial banks
Finance companies
Credit unions
Savings institutions
Nonfinancial business (GE, GMAC)
Pools of securitized assets
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15. The Cost of Making Consumer Loans (functional cost analysis)
Cost categories
Office space
Supplies
Services
Labor
Tables 12-9, 12-10, (pp ) present FCA data
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16. Credit Analysis For Consumer Lending
Five stages in the analysis of new customers:
Initial contact or introduction,
Credit application,
Review of the application,
Credit analysis or evaluation, and
Monitoring and control
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17. CAMPARI
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:
Character – the first of the five Cs
Ability – in managing financial affairs
Margin – interest rate, commission, and fees
Purpose – of the loan
Amount – of the loan
Repayment – probability of
Insurance – the collateral component of the five Cs
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18. A System Approach Versus Individual Appraisal
Credit-scoring systems have been in use for years
Examples of variables
Years on job
Home phone
Years at address
Major credit card
Credit bureau information
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19. Predicting Personal Bankruptcy
Research frameworks similar to those used in predicting corporate bankruptcy (classification models, Ch. 11)
Three national credit bureaus predict personal bankruptcies
Equifax
Trans Union
TRW
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20. Residential Real-Estate Lending: Mortgages and Home-Equity Lines of Credit
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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21. Growth Residential mtgs Bank size Growth* Small 4.9% Medium 11.5%
Large %
Top ten %
All banks % *
Home-equity loans
Bank size Growth*
Small %
Medium %
Large %
Top ten %
All banks % *
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22. The Restructuring of Residential Lending
Fragmentation of the mortgage-lending process (securitization steps)
Origination
Funding/underwriting
Selling
Servicing
Investor
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23. Subprime Lending
Subprime portfolios are those made up of loans to borrowers with higher-risk characteristics defined to include:
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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24. Myths About Subprime Lending
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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25. The Future of Consumer and Small-Business Lending
Forces shaping the future
Regulation (Table 12-17, p. 423)
Interest-rate controls cause distortions (Figure 12-3, p. 422)
New sources of fee and choice
Automation and securitization
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26. Consumer Banking Innovations
Credit and debit cards
ATMs that permit cash advances (loans)
Systems approaches to lending
Home-equity loans
On-line banking
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27. CHAPTER SUMMARY Consumer and small-business lending
Installment loans (credit cards)
Residential mortgages
Home-equity lines of credit
Loans and financial services for small businesses
Credit scoring and securitization
Subprime lending
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