Yanuar Dananjaya, Bsc.

, MM

LOAN
Types of Loan
Commercial and Industrial Loan 10%-12%
For companies
Can be short term for working capital needs, or long term for
fix asset capital, new venture start up, or permanent increase in
working capital

Real Estate Loan

Loan to purchase property, where the property is used as

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collateral for the loan

Debtor must provide down payment (about 30%)

Usually fix interest rate for certain years, then change to
adjustable rate

Individual/consumer loan
credit card, auto loan

Yanuar Dananjaya, Bsc., MM

LOAN
Some loan terminologies
Syndicated Loan a big loan provided by several banks to reduce
risk

Secured loan loan that is backed by certain asset as collateral

Unsecured loan loan without collateral (KTA kredit tanpa
agunan, +/- 20%)

Loan commitment for a certain fee, company can get

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commitment by bank to provide credit when asked in a pre-agreed

interest

Yanuar Dananjaya, Bsc., MM

LOAN
Calculating Return of Loan
Return of loan is affected by:
Base lending rate of loan
Fees relating to loan
Risk of the loan
Collateral of loan
Other nonprice term compensating balance and reserve
requirement ratio

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Base lending rate: A base rate to calculate interest rate for loan
after considering risk premium

Rate that can eb used as base rate: bank WACC, BI rate, prime
rate, LIBOR

Loan interest rate = base rate + risk premium

Yanuar Dananjaya, Bsc., MM

LOAN
Calculating Return of Loan
Fees relating to loan 0.5% - 1%
Loan Origination Fee: certain percentage of loan that must be
paid to bank when apply for loan

Compensating balance
A percentage of loan that

cannot be used and must be put in

bank

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Loan Return: k = of + (BR + rp) / 1 {b(1-RRR)}

if p = probability the loan is paid p<1 shows default risk
Expected return of loan = p(1+k) -1

Yanuar Dananjaya, Bsc., MM

LOAN
Expected Return of Loan
Expected return of loan E(r) = p(1+k) -1
The higher p, higher is expected return
The higher k, higher is expected return
However, if k is too high, it will reduce p reduce E(r)
Borrowers who are willing to borrow at high k are those intent
to invest in high risk project, thus high probability of loss and
default

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there is an optimal k where E(r) will be maximum. Higher k

will result on lower E(r)

Yanuar Dananjaya, Bsc., MM

LOAN
Retail vs. Wholesale Credit Decisions
Credit decision: whether to give loan, how much, at what interest

For each borrower, need to determine risk premium different

interest, different k

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Retail individual:
Smaller amount of loan
Large number of borrower
Difficult to get borrower data difficult to determine risk
Credit decisions only based on accept/reject and how
much, give all borrowers same interest (credit rationing) Ex:
credit card

Yanuar Dananjaya, Bsc., MM

LOAN
Retail vs. Wholesale Credit Decisions
Wholesale company:
Big amount of loan
Smaller number of borrower
Easier to get borrower data (financial report, stock movement,
analyst report, company rating, tax report, etc) easier to
determine risk

Adjust interest based on risk premium different k for

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each borrower

Higher k for higher risk company

Above the optimal k, use credit ration method
Can reduce risk by using covenant restriction
agreement that prevent company to add more loan/engage
new project/max dividend, etc

Yanuar Dananjaya, Bsc., MM

LOAN
Default Risk Models
Models to predict likeliness of default

Qualitative
Borrower specific factors
Reputation borrowing lending history of credit
applicant

Leverage The amount of debt credit applicant has in

comparison with asset, profit, cash flow, etc

Volatility of earning whether earning of credit applicant

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risky or not

Collateral
Market specific factors
Business cycle market situation that affect all
companies in general. Ex: inflation, recession, new tax, oil
price, etc

Level of interest rate

Yanuar Dananjaya, Bsc., MM

LOAN
Default Risk Models
Quantitative Credit Scoring Models

Mathematical models that use loan applicants characteristic to

calculate a score representing probability of default

Choose various characteristics of applicant, use historical

data to verify the importance of each characteristic to cause
default

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Use the result to predict the default of new loan

Examples of characteristics:
Retail: age, occupation, education, income, etc
Wholesale: cash flow, stock price, debt-equity ratio, etc

Yanuar Dananjaya, Bsc., MM

LOAN
Default Risk Models
Quantitative Credit Scoring Models

Credit scoring models can be used to:

1. Establish which characteristics are important in

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determining default risk

2.

Evaluate the relative degree of importance of these

characteristics

3.
4.
5.

Calculate numerically default risk

Screen out bad loan applicants
Estimate bad loan reserve

Yanuar Dananjaya, Bsc., MM

LOAN
Linear Probability Model
Probability of Default PD = 1 x X1 + 2 x X2 + 3 x X3 +
= weight of factor
X = factor affecting PD. Ex debt to equity ratio, debt to asset
ratio, interest rate, etc

1.Get and X from historical data by putting PD=1 for defaulted loan

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and PD=0 for paid loan, do trial and error

2.Plug in X factors of prospective borrower to the equation to get PD

3.Use formula transformed PD F(PD) = 1/ (1 + e -PD) e = 2.72
4.F(PD) will have value between 0 and 1. The nearer to 1 more likely
to default. Nearer to 0 more likely to pay

Yanuar Dananjaya, Bsc., MM

LOAN
Linear Probability Model
Weakness of Linear Probability Model:

- Only check whether paid or default. No prediction on other type of

loan problem like delay on payment, pay only partial loan,
renegotiation of interest, etc

- Changes in economic or market situation may make and X to

change

- Ignore factors that are not quantifiable. Ex reputation of borrower,

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business cycle, technology improvement, competitors, etc

- Need huge historical data

- Historical data may not be representative of new type of loan and
thus gives wrong

Yanuar Dananjaya, Bsc., MM

LOAN
Term Structure Model
Use the difference between Risk Free Rate and Company bond
interest rate as proxy for default risk

p x (1 + k) = 1 + Rf p = (1 + Rf) / (1 + k)
p = probability of payment probability of default = 1 p
k = interest rate (NOT coupon rate) of company bond
assume similar to bank loan return

Rf = Risk free rate BI interest rate

Can be continued to calculate loan expected return in case there is

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collateral

Expected return = E

(r)

= p(1+k) -1 w/o collateral

With collateral: E(r) = [{p(1+k)} + {(1 p) (1 + k)}] -1

= value of collateral / value of asset
Value of collateral must take into account the cost of taking
collateral ex legal cost

Yanuar Dananjaya, Bsc., MM

LOAN
Term Structure Model
Advantage:
Does not depend on historical data no need historical data,
not affected by changes in economic situation

Automatically reflect current economic situation through

changes in bond interest rate

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Shows probability of payment/default

Can calculate loan expected return
Disadvantage:
Can only be used for company that issue company bond
For company that has not company bond, use similar company
that has bond and add correction factor in bond interest rate
potential of inaccuracy in the correction factor