1.+ Introduction to Consumer Lending By SalimSawalha

2. + Consumer Lending Course Objective Consumer Lending Term Definitions Gain an Understanding of How Banks Make Consumer Lending Decisions Based on the Five (5) Cs of Credit Learn about Credit Investigation and Scoring Understand the Consumer Lending Process Learn about Consumer Loan Products: Credit Card, Personal, Housing, & Auto 2 3. + Consumer Lending Definition Consumer lending (also called retail lending) refers to making a wide range of loans to individuals for consumable items such as a car, house, or furniture. It is different than loans awarded to a business which is generally referred to as commercial lending. 3 4. + Consumer Lending Definition Consumer loans include: Home loans Auto loans Personal loans Credit Cards Other niche consumer-targeted loan products Many consumer-loan products are not secured by property or assets. 4 5. + Consumer Lending Consumer vs. Corporate The credit facilities extended to the corporate sector in Jordan formed the bulk of the total credit facilities extended reaching 81.7% at the end of the first half of 2010 compared to 78.4% at the end of 2009. 5 1200 1800 2500 3300 3100 3500 2700 2800 0 2000 4000 6000 8000 10000 12000 14000 16000 2003 2004 2005 2006 2007 2008 2009 May-06 Consumer Lending Corporate Lending JD in Millions 6. + Consumer Lending Type of loans There are primarily two types of loans: Termloans: A loan which is repaid through regular periodic payments (monthly, quarterly, semi annually or annually), over a period of one to 30 years. Revolving: Arrangement which allows for the loan amount to be withdrawn, repaid, and redrawn again in any manner and any number of times, until the arrangement expires. Credit card loans and overdrafts are revolving loans. 6 7. + Consumer Lending Type of loans There are primarily two types of loans: Secured Loans: A loan which is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. Unsecured Loan: is a loan that is not backed by collateral to ensure repayment Can you think of an example for an unsecured loan? 7 8. + Consumer Lending Interest Rate Definition An interest rate is the price a borrower pays for the use of money they borrow from a lender. It is typically noted on an annual basis. When the borrower is a low risk party, they will usually be charged a low interest rate; if the borrower is considered high risk, the interest rate that they are charged will be higher. 8 9. + Consumer Lending Types of Interest Rates There are primarily two types of interest rates when it comes to auto loans: Reducing Rate: an interest rate paid on the balance of the loan. Flat Rate: an interest rate calculated on the basis of the stated initial principal amount of the loan irrespective of the payment plan or the balance of the loan. This rate is often used with auto loans. 9 10. + Credit Scoring 5 Cs of Lending Most lenders use these five factors when considering a loan: Character: stability, credit history Capacity: ability to repay the loan, debt ratio, income Capital: financial position; assets, liabilities, net worth and equity. Collateral: The security offered to the lender in case of default or failure to repay the loan Conditions: changes in economy, competition, changes in banks goals and objectives 10 11. + Consumer Lending Goals for the bank The banks consumer loan application process has four primary objectives: 1. Generate a flow of consumer applications to meet the banks consumer loan objectives. 2. Obtain enough information to allow the bank to make the best possible loan decision. 3. Ensure compliance with regulations. 4. Ensure a timely response to the consumers request. 11 12. + Consumer Lending Loan Process 12 Step 1 Complete Loan Application Step 4 Closing/Funding Step 2 Processing Step 3 Underwriting 13. + Consumer Lending Loan Process 13 Step 2 Processing Gather, verify information Order/Check Appraisal Order/check Credit Report Blacklist 14. + Credit Investigation Credit Report Central 14 The Central Bank of Jordan requires that each bank provides it with a list of customers with credit facilities of 20K and above. This information is compiled from all banks and then shared electronically amongst them so that a bank can assess risk and make sound credit decisions taking into account the aggregate exposure of the customer. The information can be accessed at any time through designated users in the bank. 15. + Credit Investigation CPV Contact Point Verification is the process of verifying the authenticity of the clients information mentioned in the loan application such as business address, employer, or salary by carrying out physical inspection or through telephone call. CPV is usually done by an admin from the credit department. It is comparable to the site visit in commercial lending. 15 16. + Credit Investigation Loan Process 16 There are five basic steps in the credit investigation process: 1. Receive application and review it for information that might warrant immediate rejection 2. Check the banks credit files to determine if the application has current or closed account with the bank, review account history 3. Obtain a report from a credit-reporting agency: blacklist, central report 4. Contact employers and other creditors for references directly 5. Verify collateral value of the item(s) securing the loan 17. + Consumer Lending Loan Process 17 Step 3 Underwriting Make a Credit Decision Assign Conditions Analyze Credit Conditional Approval DeclineApprove 18. + Consumer Lending Loan Process 18 Step 4 Closing/Funding Order Loan Docs/ Contract Docs Signed & Verified Final Conditions Met Loan Funded Title Recorded 19. + Credit Scoring Definition A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information typically sourced from credit bureaus. 19 20. + Credit Scoring Why do banks use it? Lenders, such as banks, use credit scores to evaluate the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Lenders use credit scores to determine who qualifies for a loan, at what interest rate, and what credit limits. Lenders also use credit scores to determine which customers are likely to bring in the most revenue. 20 21. + Credit Scoring in the US Although there are several scoring methods, most US lenders use the FICO method from Fair Isaac Corporation. Each of the three major credit bureaus (Experian, Equifax and TransUnion) worked with Fair Isaac in the early 1980s to come up with the scoring method. The exact formula for calculating the score is proprietary information and owned by Fair Isaac. 21 300 850720+ Very Good 22. + Credit Scoring Factors affecting credit score Below are the most important factors affecting credit score: Payment history Outstanding debt (debt-to-credit-limit ratio) Length of credit history New credit inquiries Type of credit you have (revolving, installment loans) Demographic information; age, marital status, number of dependants This information is compared to the credit performance of other consumers with similar histories and profiles. Some lenders also have their own scoring methods, which may include information such as income or length of employment. 22 23. + Credit Cards A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holders promise to pay for these goods and services. A credit card allows the consumers a continuing balance of debt, subject to interest being charged. Most credit cards are issued by banks. 23 24. + Credit Cards History It was first used in the 1920s, in the United States, specifically to sell fuel to a growing number of automobile owners. Western Union had begun issuing charge cards to its frequent customers in 1921. Some charge cards were printed on paper card stock, but were easily counterfeited. In September 1958, Bank of America launched the BankAmericard. BankAmericard became the first successful recognizably modern credit card, and with its overseas affiliates, eventually evolved into the Visa system in 1976. 24 25. + Credit Cards How they work 25 26. + Credit Cards How they work 1. A cardholder selects his or her goods and presents his or her card for payment. 2. The merchant submits the purchase details to its financial institution for approval. 3. The merchants financial institution sends the purchase details to the cardholders financial institution. 4. The merchant receives a payment guarantee, and the cardholder receives the goods. 5. The cardholders financial institution remits to the merchants financial institution the retail price less the interchange rate. 6. The merchants financial institution remits to the merchant the retail price less the Merchant Discount or Merchant Service fee, which may include interchange, the cost of transaction processing, terminal rental and customer service, and the merchant financial institutions or processors margin, among other costs. 7. This charge is negotiated directly between the merchants financial institution and the merchant. 26 27. + Credit Cards How they work Electronic verification systems allow merchants to verify in a few seconds at the time of purchase that the card is valid and the credit card customer has sufficient credit to cover the purchase. The verification is performed using a point of sale (POS) system with a communications link to the merchant's acquiring bank. Data from the card is obtained from a magnetic stripe or chip on the card. 27 28. + Credit Cards Payment A credit card statement is sent monthly indicating the purchases made on the card, any outstanding fees, and the total amount owed. The cardholder must pay a defined minimum proportion of the bill by a due date or a higher amount up to the entire amount owed. The bank charges interest on the amount owed if the balance is not paid in full. If the card holder fails to make at least the minimum payment by the due date, the bank may impose a late fee" and/or other penalties. Some banks arrange for automatic payments to be deducted from the user's bank account to avoid such penalties. 28 29. + Credit Cards Interest The general calculation formula most financial institutions use to determine the amount of interest to be charged is: APR/100 x ADB/365 x number of days revolved. APR: Annual Percentage Rate ADB: Average Daily Balance 29 30. + Credit Cards Benefits to Customers The main benefit is convenience as it eliminates the need to carry any cash for most purposes. It is also considered a quick loan that can be financed for a short term. Many credit cards offer rewards and benefits packages; enhanced product warranties at no cost, free loss/damage coverage on new purchases, and points which may be redeemed for cash, products, or airline tickets. Can you think of any other benefits? 30 31. + Credit Cards Benefits to Merchants For merchants, a credit card transaction is often more secure than other forms of payment, such as checks, because the issuing bank commits to pay the merchant the moment the transaction is authorized, regardless of whether the consumer defaults on the credit card payment. In most cases, cards are even more secure than cash, because they discourage theft by the merchant's employees and reduce the amount of cash on the premises. Can you think of any other benefits? 31 32. + Credit Cards Cost to Merchants Merchants are charged several fees for the privilege of accepting credit cards. The merchant is usually charged a commission of around 1 to 3 per-cent of the value of each transaction paid for by credit card. The merchant may also pay a variable charge, called an interchange rate, for each transaction. Merchants with very low average transaction prices or very high average transaction prices are more averse to accepting credit cards. 32 33. + Credit Cards Cost to Banks Credit card issuers (banks) have several types of costs: Interest expenses Operating costs Charge offs Rewards Fraud 33 34. + Credit Cards Cost to Banks Interest expenses: Banks generally borrow the money they then lend to their customers. If the card issuer charges 15% on money lent to users, and it costs 5% to borrow the money to lend, and the balance sits with the cardholder for a year, the issuer earns 10% on the loan. This 10% difference is the "net interest spread" and the 5% is the "interest expense". 34 35. + Credit Cards Cost to Banks Operating Costs: This is the cost of running the credit card portfolio including everything from paying the executives who run the company to printing the plastics, to mailing the statements, to running the computers that keep track of every cardholder's balance, to taking the many phone calls which cardholders place to their issuer, to protecting the customers from fraud rings. Marketing and promotional programs are also a significant portion of expenses. 35 36. + Credit Cards Cost to Banks Charge Offs: When a consumer becomes severely delinquent on a debt, the creditor may declare the debt to be a charge-off. A charge-off is considered to be "written off as uncollectable." To banks, bad debts and even fraud are simply part of the cost of doing business. 36 37. + Credit Cards Cost to Banks Rewards: Many credit card customers receive rewards, such as frequent flyer points, gift certificates, or cash back as an incentive to use the card. Depending on the type of card, rewards will generally cost the issuer between 0.25% and 2.0% of the spread. 37 38. + Credit Cards Cost to Banks Fraud: When a card is stolen, or an unauthorized duplicate made, most card issuers will refund some or all of the charges that the customer has received for things they did not buy. Credit card fraud continues to be a major problem. Visa Jordan experienced a major fraud case in April 2011. All banks in Jordan stopped the credit card for their customers and issued them a replacement in order to avoid potential losses. 38 39. + Credit Cards Revenue to Banks The major income generators are: Interchange Fee (fees are typically from 1 to 6% of each sale) Interest on outstanding balance Other fees charged to the customer: Late payments or overdue payments Exceeding the credit limit on the card called over-limit fees Cash advances (often 3% of the amount) Transactions in a foreign currency (as much as 3% of the amount). Membership fees (annual or monthly) Exchange rate loading fees (sometimes these might not be reported on the customer's statement, even when applied). 39 40. + Credit Cards Visa World Visa Inc. is the worlds largest retail electronic payments network, with US$5.2 trillion transacted as of December 31, 2010. 15,700 Financial institution customers 1.85 billion Visa cards (As of September 30, 2010) $5.2 trillion Total volume** 1.8 million ATMs*** (As of September 30, 2010) 71 billion Total transactions**** 40 41. + Credit Cards Interest Rate Interest rate for credit cards is usually the highest compared to other consumer lending products. It ranges from 1.75% to 2.5% monthly. Many issuers have moved to variable-rate pricing that ties movements in their interest rates to a specified index such as the prime rate. Interest rate can also change depending on credit risk, consumer usage patterns and behavior. 41 42. + Debt Burden Ratio Debt Burden Your debt burden is simply the sum of all periodic debt payments you must make. The monthly debt burden would be the amount of money you must pay to your creditors every month. This may include monthly minimum credit card payments, home loan payments, car payments and other recurring bills from creditors. 42 43. + Debt Burden Ratio Debt Burden Ratio (DBR) The debt burden ratio is defined as your debt burden divided by your net income. If the total monthly debt payments are 250 JOD and your take- home, after-tax pay is 500 JOD per month, your debt burden ratio, expressed in percentage terms, is 50 percent. The higher the debt burden ratio, the less of your income is "disposable," or available to spend as you wish. 43 44. + Debt Burden Ratio Exercise Calculate the DBR for the following applicant: Monthly income before tax: 1500 JDs Monthly deductions and tax: 300 JDs Rent: 300 JDs Car Loan: 200 JDs Water Bill: 30 JD Electricity Bill: 80 JDs 44 45. + Certified Companies A certified company is a company that has been pre-approved by the bank as having a sound business practice and strong financial position. The bank does the certification exercise through studying and analyzing the financial statements and business activity of the company. As a result of the above, it is usually less risky to extend credit facilities to a certified company. 45 46. + Prime Rate Prime rate or prime lending rate is a term applied in many countries to reference the rate of interest at which banks lend to favored customers, i.e., those with high credibility (usually the most prominent and stable business customers). 46 47. + Prime Rate The rate is almost always the same amongst major banks. Adjustments to the prime rate are made by banks at the same time; although, the prime rate does not adjust on any regular basis. The Prime Rate is usually adjusted in correlation to the adjustments of the Central Bank of Jordan key lending rates (discount rate, deposit window). If banks must pay more to borrow, they raise the prime rate. If their cost drops, they drop the prime rate. 47 48. + Social Security Statement Social Security Statement is issued by the Social Security department and it shows the salary the individual has earned over the years that has been subject to social security deductions. Many banks use the social security statement to verify the income of the loan applicant. 48 49. + Early Payment Most banks charge the customer a penalty called prepayment penalty or early payment penalty when the loan is either paid off completely or in part before its maturity. The penalty is usually based on percentage of the remaining mortgage balance or a certain number of months worth of interest. Why do lenders charge a prepayment penalty? 49 50. + Early Payment The prepayment penalty ranges from 2% to 8% across banks. Things to keep in mind regarding the prepayment penalty: 1. It is usually lower if the customer pays off the loan or part of it from his own funds compared to a buy-out. 2. Most banks wont allow for a partial prepayment amount less than one monthly loan payment. 50 51. + Loan to Value Loan to Value (LTV) refers to the ratio of the amount you owe on a loan compared to the home's value. Thus, if your loan is for 80,000 JDs on a 100,000 JD home, your loan to value would be 80%. That also means that you have 20% equity in your home. When you apply for a loan, LTV will be taken into account and will be used to determine several things such as interest pricing. The logic is that the higher loan-to-value, the more risky the loan is for the lender. 51 52. + Salary Transfer The process of transferring an employees monthly salary to a certain party, usually the bank. This is done with a commitment letter from the employer to the bank. However, the commitment does not constitute a guarantee of the loan by the employer. 52 53. + Guarantor A guarantee, in finance, is a promise by one party (the guarantor) to assume responsibility for the debt obligation of a borrower if that borrower defaults. The person or company that provides this promise, is also known as a surety or guarantor. 53 54. + Cash Margins Cash margin loans are the least risky as they are guaranteed by the customers cash collateral. Banks require 110% or 120% of the loan amount for cash collateral loans. Such loans are executed with quick turnaround from application (24 hours) and require minimal approval levels. Example: A customer applies for a personal loan of 5,000 JDs. He has a term deposit with the bank for 20,000 JDs. What is the amount of his deposit that will be set aside as collateral at 110%? 54 55. + Loan Agreement A contract is a legally enforceable agreement between two or more parties with mutual obligations A loan agreement is a contract entered into between which regulates the terms of a loan. 55 56. + Loan Agreement Contents of a Loan Agreement Characteristically a professionally drafted loan agreement will incorporate the following terms: Parties to contracts with their addresses Definitions or interpretation provisions Type of loan and purpose Payment provisions Repayment term provisions Prepayment and cancellation provisions Interest and interest periods Events of late payment, default and their remedies Provisions for fees of the lenders Amendments and waivers provisions 56 57. + Loan Agreement Contents of a Loan Agreement Exercise Read the attached loan agreement. Do you believe the contract left out anything important? If so, list the items the contract failed to cover. 57 58. + Credit Cards Credit Policy The below is an example of a credit policy for a bank in regards to credit cards: Minimum age of customer: 21 Maximum age of customer: 60 Target market: salaried employees as follows: 400JDs minimum for transferred salary 500JDs min for non-transferred salary Employment term: 3 months for certified companies Credit limit: 6 times monthly salary for certified companies, 3 times for other DBR: 60% for transferred salary, 50% for non-transferred salary 58 59. + Personal Loan Definition A loan that is granted for personal use; usually unsecured and based on the borrower's integrity and ability to pay. It is usually made for the purpose of debt consolidation, vacation or the purchase of durable goods. 59 60. + Personal Loan Loan Term & Interest Rate The term ranges from 3 to 8 years. The interest rate ranges from 9% to 13%. 60 61. + Housing Loans Definition A housing loan is a very common type of debt instrument, used by many individuals to purchase housing. In this arrangement, the bank lends money to the borrower to purchase the property. In return, the bank is given security a lien on the title to the house until the loan is paid off in full. If the borrower defaults on the loan, the bank would have the legal right to repossess the house and sell it, to recover sums owing to it. 61 62. + Housing Loans Banking Law The Banking Law has prohibited any bank operating within the Kingdom from granting loans for the construction or purchase of real estate in excess of 20% of the banks total JD deposit. 62 63. + Housing Loans Loan Term The duration of the loan period is considerably longer compared to other consumer lending products often corresponding to the useful life of the property and the relatively higher loan amount. The term usually ranges from 10 to 30 years. 63 64. + Housing Loans Interest Rate Interest rate on home loans range from 7% to 10%. Most banks charge an annual fee on top of 0.5% to 1% whether for the first year only or for the life of the loan. 64 65. + Auto Loan Definition An auto loan (sometimes referred to as car loan) is a personal loan used to purchase an automobile whether new or old. 65 66. + Auto Loan Interest Rate The interest rate on car loans are usually flat. It ranges from 5% to 7%. For reducing interest rates, the range is between 9% to 11%. New cars are usually financed with lower interest rates and higher LTV compared to used cars. 66 67. + Auto Loan Loan Term The duration of the loan period is shorter compared to housing loan often corresponding to the useful life of the auto. The term usually ranges from 3 to 7 years. 67 68. + Auto Loan Loan Requirement Most banks require that the following to extend the loan: A lien on the title of the car Full insurance coverage Full car inspection from a certified mechanic for used cars 68 69. + Consumer Lending Classification of Credit Facilities Credit facilities can be classified into 4 types: Low risk facilities: government loans, 100% cash margin loans Acceptable risk facilities: adequate cash flow, acceptable collateral, competent financial management of the customer, timely payments Watch-list facilities: past dues over 60 days but less than 90 days Non-performing loans: 69 Sub-standard 90-179 Days Doubtful 180-359 Days Loss 360 Days and Over 70. + Consumer Lending Loan Loss Provisions Loss provisions are a non-cash expense for banks to account for future losses on loan defaults. Banks assume that a certain percentage of loans will default or become slow-paying. Banks enter a percentage as an expense when calculating their pre-tax incomes. It appears under the owners equity section of the balance sheet as a separate item. This guarantees a bank's solvency and capitalization if and when the defaults occur. 70 71. + Consumer Lending Loss Provisions According to Type Acceptable risk facilities: 1% of the total direct credit facilities Watch-list facilities: 3% of the total direct credit facilities 71 72. + Consumer Lending Non-Performing Loss Provisions Credit facilities not covered by eligible Collateral 72 Sub-standard 25% Doubtful 50% Loss 100% Credit facilities fully covered by eligible Collateral The impairment loss provision should be gradually created over a 5 year period to reach 100% coverage by the end of the fifth year (i.e. 20% per annum) 73. + Consumer Lending Non-performing Loans to Total Loans Ratio The quality of banks' assets in Jordan witnessed a major improvement during the years 2003-2008, when the ratio of nonperforming loans to total loans dropped from 15.5% at the end of 2003 to 4.2% at the end of 2008. During the first half of 2010, the ratio increased once again, reaching 7.9%. This increase came as a natural result of the repercussions of the global financial crisis. 73 74. + Consumer Lending Non-performing Loans to Total Loans Ratio 74 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 2003 2004 2005 2006 2007 2008 2009 May-06 Non-Performing Loans to Total Loans Ratio, %