To Loan or Not to Loan A Subprime Dilemma The Leftovers: Kyle Suffolk Miranda TaylorAndrew...

To Loan or

Not to Loan A Subprime Dilemma

The Leftovers:

Kyle Suffolk Miranda Taylor Andrew Vaughn Johan Wislander Anzhelika Zaborskikh

2

Credit ScoresJohan

Federal Reserve Kyle

Financial AnalysisAnzhelika

Strategic Considerations Andrew

Ethical Issues Miranda

RecommendationAndrew

3

Regression Relationships

• Negative Relationship

• Low Credit Score = Many Days Delinquent

• High Credit Score = Few Days Delinquent

375 425 475 525 575 625 675 725 775 8250

10

20

30

40

50

60

70

80

90

100

Credit Score

Da

ys D

eli

nq

ue

nt

Y=-203,65-0,255x

The Leftovers: Johan

4

Regression Relationships

• Coefficient of Determination

R-Square:

0.926 or 92.6 %

• Credit Scores explain 92.6 percent of the movement of Days Delinquent


375 425 475 525 575 625 675 725 775 8250

10

20

30

40

50

60

70

80

90

100R² = 0.925685559877387

Credit Score

Da

ys D

eli

nq

ue

nt

5

Credit Score: Average Delinquent of 90 days

Loans are likely to be foreclosed if they pass 90 days delinquency

We can find the average credit score for 90 days delinquent by using our regression equation.

• Y = 203.65 - 0.255x • 90 = 203.65 – 0.255 * Credit Score

Credit Score = 446


6

Credit Score: Average Delinquent of 90 days

• Normal Distribution

• Bell Curve

• Symmetric Distributed

• 50 percent of the people with credit score of 446 are likely to be 90 or more days delinquent


Days Delinquent

7

Subprime Loans

Prime Loans (Credit Score 640 and up) Low Risk

Financially stable borrowers

Likely to pay on time

Subprime Loans (Credit Score 639 and down) High Risk

Less responsible borrowers

Less favorable terms, higher interest rate


8

Minimum Credit Score Recommendation

Minimum Credit Score: 550Average Days

Delinquent 64 days

Consider Higher Deposit

Acceptable Risk


9

Federal Reserve

Federal Reserve =

Central Bank of the United States

Manipulates:

• Money Supply

The Leftovers: Kyle

10

Decreased Supply of Loanable Funds

Decreased Borrowing

and Lending

Increased Interest

Rate

The Leftovers: Kyle

11

Home Price Change by Interest Rates

0.000 1.000 2.000 3.000 4.000 5.000 6.000 7.000 8.000 9.000 10.0000.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

R² = 0.175188131909654

Interest Rates

Hom

e P

rice C

han

ge

The Leftovers: Kyle

12

Impacts

FirstMoral

Hazard Problem

Unable to Refinance

SecondDefault Rate of

3-5%

Underwater

The Leftovers: Kyle

13

Monthly Interest Rate

Average home loan - $200,000

Interest rate on subprime loan – 8 %

(6% interest rate for prime loan + 2% premium)

Annual interest rate on $200,000:

$200,000 x 8% = $16,000

Monthly interest amount:

$16,000/12 months = $1,333.33

The Leftovers: Anzhelika

14

Average Interest Loss

The average number of months without interest – 7.5 months

The average interest loss (per loan that became delinquent):

1,333.33 x 7.5 months ≈ $10,000


15

Expected Loss

Average probability of default – 4%

Average interest loss $10,000

Premium – 2% ($4,000)

Yes


16

Example


17

Example


18

Example Explanation

Premium on 96 out of 100 home loans (performing loans): $4,000 x 96 home loans = $384,000

Expected loss from 4 out of 100 home loans (nonperforming loans): $10,000 x 4 home loans= $40,000


19

Strategic Consideration

• Credit Score Below 640• Risk too high

Establish Minimum Credit

Score

• 4 out of 100 homes would default• Higher risk with assumed market

terms

Subprime Market, Assumed Terms

• Deposit of 15%• Scores Below 550 are less likely to

pay

Enter into the Subprime Market

The Leftovers: Andrew

20

StakeholdersPri

mary Banks Secondary

Market

Prime Borrowers

Subprime Borrowers

Seco

nd

ary

Home Owners

Real Estate Agents

Bank

The Leftovers: Miranda

21

Ethical Theories

Utilitarian

Greatest good to greatest number

Categorical ImperativeWhat if everyone acted this way?


22

Entering the Subprime Market?

Utilitarian Theory

Negatively effect stakeholders

More harm than benefit

Major Effect on

• Banks

• Prime Borrowers

• Secondary Market

Unethical

Categorical Imperative

Same opportunities for any borrower

Value of Credit Score

Major Effect on

• Prime Market

• Subprime Market

Unethical


23

Recommendation

Enter into

Subprime Market

Higher Deposit

Credit Score over 550

Secondary Market

The Leftovers: Andrew

24

Ethical Analysis: Recommendation

Utilitarian Theory

Benefits Stakeholders

More Benefit than Harm

Major Effect on

• Banks

• Prime & Secondary Borrowers

• Secondary Market

Ethical

Categorical Imperative

Same opportunities for Borrowers

Value of Credit Score Kept

Major Effect on

• Prime Market

• Subprime Market

Ethical


25

Thank You!

The Leftovers

26

References

Anonymous. To Loan or Not to Loan. Student Coaching Notes [PowerPoint slides].

Retrieved from https://moodle.csun.edu/course/view.php?id=65384/index.html

Anonymous. To Loan or Not to Loan. Data [Excel spreadsheets].

Retrieved from https://moodle.csun.edu/course/view.php?id=65384/index.html

Anonymous. Statistics Review Material. Key Concepts 4, 5, 6, 8 [PowerPoint slides]. Retrieved from

http://www.csun.edu/cobaessc/statistics-review-material

Anonymous. Macroeconomics Review Material. Key Concepts 4, 6, 7, 9 [Pdf documents]. Retrieved from

http://www.csun.edu/cobaessc/macroeconomics-review

Anonymous. Ethical Decision Making [PowerPoint slides]. Retrieved from

https://moodle.csun.edu/course/view.php?id=65384/index.html

Johnson, G., Roberts, W., & Trybus, E. (2009). To Loan or Not to Loan: A Subprime Dilemma [Pdf document].

Retrieved from https://moodle.csun.edu/pluginfile.php/2301725/mod_resource/content/0/To Loan or Not to

Loan - Case Text.pdf

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