Types of Lending

Fund Based Lending

WC loan Housing loan

Non-Fund Based Lending

Contingent liabilities

Letter of Credit

Asset Based Lending

The Credit Process

Loan Objectives
Volume and mix of loans Loans evaluation procedure Credit administration Credit files

Lending rates

The Z-score Model

First developed by Altman in 1968 Uses a specified set of financial ratios as

variables in multidiscriminant statistical methodology (MDR) Real world application of the Altman score successfully predicted 72% of bankruptcies 2 years prior to their filing.

Multi Discriminant Analysis

Used to classify an observation into several groupings
The groupings are based on an observations individual characteristics MDR is used while making predications in problems where the variable

dependant variable appears in qualitative form. Eg. Bankrupt and nonbankrupt Forms a linear equation using characteristics that can be used to distinguish between the dependant variable groups

Z = V1.X1 + V2.X2 + +VnXn

V1Vn = discriminant coeff. X1Xn = independent variables Z = discriminant function

Z-score model :reprise

Uses five financial ratios
Ratios are objectively weighed and summed Ratios can be obtained from corporations financial

statements
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 X1 = Working Capital/total assets X2 = Retained Earnings/total assets X3 = Earnings before interest and taxes/total assets X4 = Market value equity/book value of total liabilities X5 = Sales/total assets Z = Overall index

Z-score constituent ratios

Working Capital/total assets (WC/TA)
Working Capital is the difference between the current assets and current liabilities as

obtained from the balance sheet

Retained Earnings/total assets ( RE/TA)

Retained Earning is also know as the earned surplus It represents the total amount of reinvested earnings and/or losses of a firm over its

entire life-cyle Can be obtained from balance sheet

Earnings before interest and taxes/Total assets (EBIT/TA)

Measure of a corporations earning power from ongoing operations Also know as Operating profit Watched closely by creditors as it represent the total amount of cash that a

corporation can use to pay off its creditors Can be obtained for the Income statement

Z-score constituent ratios Continued

Market Value of Equity/Book Value of total liabilities (MVE/TL)
The market value of equity is the total market value of all of the stock, both

preferred and common The book value of liabilities is the total value of liabilities both long term and current The MVE/TL shows how much the firms assets can decline in value with increasing liabilities, before the liabilities exceed the assets

Sales/Total Assets (s/TA)

Also known as capital turnover ratio Illustrates the sales generating ability of the corporations assets

Z score Results
Based on Z-scores averaged over time, Altman calculated

that IF Z < 1.81 serious credit problems IF Z > 2.99 healthy company IF 1.81<Z<2.99 zone of ignorance