Chapter Seventeen

Lending to Business Firms and Pricing

Business Loans
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Key Topics
• 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 (CPA)

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Short Term Business Loans

• Self-Liquidating Inventory Loans
• Working Capital Loans
• Interim Construction Loans
• Security Dealer Financing
• Retailer and Equipment Financing
• Asset-Based Financing
• Syndicated Loans

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Short Term Business Loans

• Self-Liquidating Inventory Loans

• Working Capital Loans “used to cover seasonal needs”

• Interim Construction Loans

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Short Term Business Loans

• Security Dealer Financing

• Retailer and Equipment Financing

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Short Term Business Loans

• Asset-Based Financing
The most common example of this is factoring:

• Syndicated Loans
Syndicated Loans normally consists of a loan package extended to a
corporation by a group of lenders. Lenders engage in syndicated loans both to
reduce risk exposure of these large loans, and to earn fee income (such as
facility fees to open a credit line)

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Long Term Business Loans

• Term Loans
• Revolving Credit Lines
• Project Loans
• Loans to Support Acquisitions of Other
Business Firms

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Long Term Business Loans

• Term Loans

• Revolving Credit Lines

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Long-term Business loans

• Project Loans

Acquisition loan

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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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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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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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Component of Sources and Uses of

Funds Statement

• Cash Flows from Operations

• Cash Flows from Investing Activities
• Cash Flows from Financing Activities

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Credit analysis
• Comparing a business customer’s
performance to the performance of its
industry
• It is standard practice among loan officers
to compare each business customer’s entire
industry.

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Contingent Liabilities:
usually not shown on customer balance sheets are other potential
claims against the borrower that loan officers must be aware of

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Types of Contingent Liabilities

• Guarantees or Warrantees Behind
Products
• Litigation or Pending Lawsuits
• Unfunded Pension Liabilities the firm
will likely owe its employees in the
future
• Taxes Owed But Unpaid
• Limiting Regulations

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Methods Used to Price Business

Loans
• Cost-Plus Loan Pricing Method
• Price Leadership Model
• Below Prime Market Pricing
• Customer Profitability Analysis

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Cost-Plus Loan Pricing

Marginal
Cost of Estimated
Nonfund Bank's
Loan Raising Margin to
Bank Desired
Interest = Loanable + + Compensate +
Operating Profit
Rate Funds to Bank for
Costs Margin
Lend to Default Risk
Borrower

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Cost-Plus Loan Pricing

• Suppose a bank estimates that the marginal
cost of raising loanable funds to make a
$10m loan to one of its corporate customers
is 4%, its nonfunds operating costs to
evaluate and offer this loan are 0.5%, the
default-risk premium on the loan is 0.375%,
a term-risk premium of 0.625% is to be
added, and the desired profit margin is
0.25%. What loan rate should be quoted this
borrower? How much interest will this
borrower pay in a year?
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Price Leadership Model

Default
Risk Term Risk
Loan
Base or Premium Premium for
Interest = + +
Prime Rate for Non- Longer
Rate
Prime Term Credit
Borrowers

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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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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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Below-Prime Market Pricing

Interest Cost
Loan Markup
of Borrowing
Interest = + for Risk
in the Money
Rate and Profit
Market

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Customer Profitability Analysis (CPA

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Customer Profitability Analysis (CPA)

• Estimate Total Revenues From Loans and

Other Services
• Estimate Total Expenses From Providing Net
Loanable Funds
• Estimate Net Loanable Funds
• Estimate Before Tax Rate of Return By
Dividing Revenues Less Expenses By Net
Loanable Funds

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Quick Quiz
• What aspects of a business firm’s financial
statements do loan officers and credit analysts
examine carefully?
• What methods are used to price business loans?
• Suppose a bank estimates that the marginal cost of
raising loanable funds to make a $10m loan to one
of its corporate customers is 4%, its nonfunds
operating costs to evaluate and offer this loan are
0.5%, the default-risk premium on the loan is
0.375%, a term-risk premium of 0.625% is to be
added, and the desired profit margin is 0.25%.
What loan rate should be quoted this borrower?
How much interest will this borrower pay in a year?
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