T.3_BANKING AND FINANCIAL INSTITUTIONS (2017)Apunte Inglés
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BANKING AND FINANCIAL INSTITUTIONS
T-3. FINANCE AND BORROWING
Banks financing activities are those credit operations included in the assets side of the
balance sheet. Here, banks face credit risk related to the probability of client’s default
when paying its debt.
- Loans vs Revolving facilities A loan is debt provided by the bank (lender) to its customer (borrower) evidenced by a note which specifies: principal amount, interest rate and repayment calendar.
Some specific terms: Principal of the loan: amount of money lent Pay Back or Repayment: payments agreed in the loan agreement Installments: specified amounts to be repaid in the amortization scheme: an annuity, monthly payments, etc… Interest rate: financial conditions for the loan Contract: agreement specifying obligations and restrictions in the loan The lender gives the principal to the borrower The borrower has to repay the principal and corresponding interests in the specified installments Opening fee: initial fee for doing a loan Covenants: additional restrictions in a loan operation A revolving facility (credit line) is a type of credit that does not have a fixed number of payments; it’s a bilateral contract between the bank and their clients where the bank provides a maximum amount to be used by the customer, who could request at any moment any amount within this limit.
Some specific terms: The credit could be used repeatedly Opening fee: charged at the opening of the credit line Commitment fee: charged as a % of non-used amounts The customer only pays interest rate over used amounts At the maturity date, the customer has to pay back the facility Thus, common terms among these two assets are: Opening fees Early amortization fee Interest rate (annual- nominal or effective %) 1 o - The effective annual interest rate takes compounding and fees into consideration (so you can see the actual cost or yield of an investment) and is thus almost always higher than the annual interest rate.
Default interest rate Families and Individuals Retail banking-families are focused usually in loans for equipment (from 1 to 10 years) or house financing (more than 10 years). Another recurrent asset are credit cards facilities. Banks usually differentiates between personal loans (with or without an specific final destination) or housing loans (mortgages). The maximum duration is defined, and the interest rate it’s commonly fixed. Monthly installments can be fixed or growing; deferred or irregular payments can be foreseen.
o Credit Cards Debit card: Immediate payment Credit card: Deferred payment (1 month free credit) Revolving credit card: additional credit, full or partial outstanding balance is deferred for a longer period.
Affinity card: Issued by companies as special card for customers. Either credit or debit cards. Either Co-branded or Private label cards.
Essential terms of credit cards: Cardholder: The holder of the card used to make a purchase; the consumer.
Card-issuing bank: The financial institution or other organization that issued the credit card to the cardholder. This bank bills the consumer for repayment and bears the risk that the card is used fraudulently.
Merchant: The individual or business accepting credit card payments for products or services sold to the cardholder.
Acquiring bank: The financial institution accepting payment for the products or services on Credit Card association: An association of card-issuing banks such as Discover, Visa, MasterCard, American Express, etc… that set transaction terms for merchants, card-issuing banks and acquiring banks.
Transaction network: The system that implements the mechanics of the electronic transactions. May be operated by an independent company, and one company may operate multiple networks.
Affinity partner: Some institutions lend their names to an issuer to attract customers that have a strong relationship with that institution, and get paid a fee or a percentage of the balance for each card issued using their name.
Examples of typical affinity partners are sports teams, universities, charities, professional organizations, and major retailers.
Insurance providers: Insurers underwriting various insurance protections offered as credit card perks, for example, Car Rental Insurance, Purchase Security, Hotel Burglary Insurance, Travel Medical Protection etc.
o Mortgages 2 Mortgages are used in order to purchase a house for personal costumers, but can be also used as an additional guarantee for operations. The amount borrowed can’t be the same amount than the price of the house. Some characteristics: - - - LTV: Loan to Value, being the result of dividing the amount of the loan over the value of the house. Banks set it to a maximum, around 60-80%. This means that the 20-40% of the value of the house is paid with personal savings.
Term: The time it will take to repay the mortgage, usually 20-30 years. As a general rule, the term + the age of the borrower can’t be more than 70 years.
Interest: Usually it’s paid a monthly amount as interests (or interests+capital) in order to repay it. Those can be: o Fixed: fixed rate, usually when is due less than 20 years o Floating: uses an index (Libor or Euribor) plus a spread (depending on the relationship customer-bank) o Capped: this rate is allowed to fluctuate but up to a concrete interest (it cannot surpass a stated interest cap There can be some compulsory or linked products to set final price (monthly remittance, insurance, credit cards, pension plans…).
Fees: Analyzing and open, and early closing fee.
Other expenses: House valuation, insurances, real estate register and notary, taxes, third party assessment.
Another particularity is the possibility of subrogate a mortgage. This can be: - Change in debtor: When the borrower in the mortgage changes (the house is sold and the new buyer gets the existing mortgage).
Change in creditor: When the lender in the mortgage changes (you decide to change from one bank to another because of getting better conditions). When you change the conditions of a mortgage, it’s called novation.
Specific terms: - - - - Deeds of the property: A deed is a legal instrument that transfers some property right in real estate. Deeds in their most basic form contain: o A description of the real estate involved o The names of the respective parties o The signature of the person transferring the real estate Installments: A series of payments that a buyer makes instead of a lump sum to compensate the seller.
Eviction: The casting out of a tenant from a tenancy. For example, a landlord may evict a resident of an apartment for non-payment of rent. However, the landlord must give notice a certain number of days before an eviction may take place.
Foreclosure: A situation in which a mortgage lender takes possession of the property because the borrower has not made payments for a certain period of time. Once the lender takes over the property, it usually sells at a discounted price so as to recover the amount lost on the mortgage loan.
Asset-based lending: The practice of making a loan secured by an asset. While, in theory, many loans are asset-based mortgages, the tem most commonly 3 - - applies to loans secured by something unusual, such as accounts receivable or intellectual property. Businesses take out most asset-based loans and pledge something used in the conduct of their businesses as collateral, such as inventory. As with all secured loans, asset-based loans have lower interest rates than unsecured loans.
Pledge: Delivery of goods or personal property as security for a debt or obligation.
Business and Corporations o Short term operations A firm obtains its funds from a variety of sources. Some capital is provided by suppliers, creditors, and owners, while other funds arise from earnings retained in business. In this segment, let me explain to you the sources of short-term funds supplied by creditors.
Characteristics of short-term financing: 1. Cost of Funds: Some forms of short-term financing may prove to be expensive than that of intermediate and long-term financing while some short-term sources like Accruals and Payables provide funds at no cost to the firm.
2. Rollover Effect: Short-term finance as the name indicates must be repaid within a period of one year – though some sources provide funds that are constantly rolled over. The funds provided by payables, may remain relatively constant because, as some accounts are paid, other accounts are created.
3. Clean-up: This happens when commercial banks or other lenders demand the firm to pay-off its short term obligation at one point in a financial year.
Goals of Short-Term Financing: Funds are needed to finance inventories during a production period. Short term funds facilitate flexibility wherein, it meets the fluctuating needs for funds over a given cycle, commonly 1 year.
To achieve low-cost financing due to interest free loans.
Cash flow from operations may not be sufficient to keep up with growth-related financing needs Interest Free Sources: - Accounts Payable Accounts payable are created when the firm purchases raw material, supplies, or goods for resale on credit terms without signing a formal note for the liability. These purchases on ―open account‖ are, for most firms, the single largest source of short-term financing. Payables represent an unsecured form of financing since no specific assets are pledged as collateral for the liability. Even though no formal note is signed, an accounts payable is a legally binding obligation of a firm.
Postponing payment beyond the end of the net (credit) period is known as ―stretching accounts payable‖ or ―leaning on the trade.‖ Possible costs of ―stretching accounts payable‖ are 4 Cost of the cash discount (if any) forgone Late payment penalties or interest Deterioration in credit rating Accruals: These are short term liabilities that arise when services are received but payment has not yet been made. The two primary accruals are wages payable and taxes payable. Employees work for a week, 2 weeks or a month before receiving a paycheck. The salaries or wages, plus the taxes paid by the firm on those wages, offer a form of unsecured short-term financing for the firm.
The Government provides strict rules and procedures for the payment of withholding and social security taxes, so that the accrual of taxes cannot be readily manipulated. It is however, possible to change the frequency of paydays to increase or decrease the amount of financing through wages accrual.
Wages — Benefits accrue via no direct cash costs, but costs can develop by reduced employee morale and efficiency.
Taxes — Benefits accrue until the due date, but costs of penalties and interest beyond the due date reduce the benefits.
Unsecured Interest Bearing Sources: Self-Liquidating Bank Loans The bank provides funds for a seasonal or cyclic business peak and the money is used to finance an activity that will generate cash to pay off the loan.
Borrowed Funds → Finance Inventory → Peak Sales Season → Receivables → Cash → Pay Off the Loan.
Three types of unsecured short-term bank loans: 1. Single payment note – A short-term, one-time loan made to a borrower who needs funds for a specific purpose for a short period of time.
2. Line of Credit – An informal arrangement between a bank and its customer specifying the maximum amount of credit the bank will permit the firm to owe at any one time. One-year limit that is reviewed prior to renewal to determine if conditions necessitate a change. Credit line is based on the bank’s assessment of the creditworthiness and credit needs of the firm.
―Cleanup‖ provision requires the firm to owe the bank nothing for a period of time.
3. Revolving Credit Agreement – A guaranteed line of credit that the firm van borrow up to a specific limit regardless of the degree of tightness of money.
Definitions: - Credit Line (revolving credit facility): 5 o o o o o o - - Opening fee: % over total limit. Paid when the agreement is signed or extended.
Commitment fee: % over unused balances.
Interest rate for used amounts (fixed or variable) Overdraft interest rate and corresponding fee Nottary costs Another expenditures (information reports or requests) Commercial Discount (commercial paper): SPECIFIC (Spanish documents) representing a future payment between customer and supply.
o Letra de cambio (bill of exchange, promissory note) o Pagaré comercial (promissory note, note) o Pagaré de cuenta corriente o Recibo comercial (bill, receipt) o Pago domiciliado o Créditos presentados en Norma 58 (credit advances, regulation 58) o Recibos comerciales presentados en Norma 32 (regulation 32) Receivables discounting: Advancing the amount of the collection rights with regard to the debtors of the company, derived from the operations pertaining to your business activity and from the unmatured commercial loans that the company has with third parties. The customer receives net amount, once interests and fees have been deducted. The bank keeps commercial paper until maturity and acts as collector for the customer. Normally with recourse, so if the customer fails to pay, the company that transferred the note to the bank is liable for the full amount.
The main terms are: INTEREST RATE: ―liquidación al tirón‖ N (1-d*t/360) MATURITY DATE FEES TAXES (if any) COMPENSATIONS: E* = N (1-d*t/360)-gN-G-RN - Factoring Financial transaction in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. Full transmission 6 of receivables in a customer balance. The bank offers the customer advancing these receivables. The bank manages these receivables to cash them. Non recourse factoring. With recourse factoring: the factor assumes full responsibility for collecting the money owed in order to recoup its financial layout for the account (commercial risk is never satisfied). In finance, the selling of accounts receivables on a contract basis to an agency known as a factor in order to obtain cash payment before the accounts come due. The factor assumes full responsibility for credit analysis of new accounts, payments collection, and credit losses.
Main terms: - Factoring fee: % OVER TOTAL RECEIVABLES - Interest rate: The customer pays over ―used‖ amounts - Opening fee: % OVER TOTAL LIMIT, when the limit is signed - Other: % OVER NON USED AMOUNTS, if some minimum is agreed.
- Confirming: Reverse factoring. Global supply-chain finance. Managing company’s payables. Financing solution initiated by the ordering party in order to help his suppliers to finance their receivables more easily and at a lower interest rate than what they would normally be offered. Financial instrument allowing the supplier to be financed by a bank who acts on behalf of its client.
Customer informs the bank about its pending invoices and terms of payment.
The bank contact customer’s suppliers and offers an advanced payment without recourse.
- Exports and Imports financing: Foreign markets operations could be also financed. Exports. Imports. Increase in alternate instruments like forfaiting and international factoring o Long term operations Provide necessary fund for the growth of the company or necessary capex investments: longer tenors, Loans, Financial Lease, Operating lease (renting)… - Loans Used for equipment acquisition, acquisition financing, reestructuring processes… Principal: total amount of the loan. Principal should be repaid in installments, as signed in the loan agreement. (Syndicate loans, Project finance…) - Leases (financial and operational lease) Contractual agreement calling for the lessee (user) to pay the lessor (owner) for use of an asset. Usually the lessee is a company willing to have an asset and the lessor is a bank which accepts financing this asset, by buying it and starting a rental agreement with the company. (Equipment Lease, Real State Lease, Lease back…). al vencimiento el arrendatario dispone de tres opciones: devolver los bienes a la sociedad, convenir un nuevo contrato de arrendamiento y adquirir los bienes por su valor residual.
Main participants: 7 - LESSOR: bank or specialized company providing for this transaction LESSEE: company signing lease agreement. Enjoy the utilization of the good and becomes the owner if acquisition option is exercised.
SUPPLIER: seller of the good Main terms: - - Opening fee Financial expenses (interest rate fix or variable) Insurances for loss Initial payment (security deposit) to grant the contract Final payment (residual value) to get the ownership of the good Taxes (VAT): las cuotas y el valor residual están sujetos a IVA, al tipo impositivo que corresponda. En el caso de leasing inmobiliario en la compraventa del inmueble se darán dos variantes. En primera transmisión el arrendador paga el IVA al vendedor. En segunda y ulteriores, si el vendedor es empresario o profesional, estará sujeta pero exenta de IVA. Si el vendedor es un particular, no-empresario o profesional, la venta no estará sujeta a IVA, sino a ITP.
Operating lease Short term lease of an asset. The lessor leases the equipment to the lessee which pays periodically a rent but the title to the asset does not pass to the lessee. At the end there is not the option to buy the asset, and the lessee can renew the contract, the equipment o return it. They are operating expenses, no effect on the balance sheet.
(Cars, Software, small equipment, Hardware…) Características Las características del producto permiten también su diferenciación del leasing: - predomina el componente de servicios sobre el financiero - no es un producto tan regulado como el leasing, con lo que plazos, beneficiarios, precios,... son diferentes - no incorporan opción de compra - Guarantees 8 Off-balance products, initially no money is borrowed by the customer from the bank.
The bank commits to a third party. The commitment would take place if the customer does not accomplish with some payment or action. A guarantee from a lending institution ensuring that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it. Potential risk for the bank. Any amount is delivered at the signature of the guarantee. A bank guarantee enables the customer (debtor) to rent a building, acquire goods, buy equipment, getting some contracts from Administration, draw down loans, etc.. Performance bond, bid bond.
A bank guarantee, like a line of credit, guarantees a sum of money to a beneficiary.
Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. This can be used to essentially insure a buyer or seller from loss or damage due to nonperformance by the other party in a contract.
Coverage products: The bank assumes some commitment regarding the evolution of certan indicators such as interest rate or exchange rate.
Letter of credit-international payments: A letter of credit is an obligation taken on by a bank to make a payment once certain criteria are met. Once these terms are completed and confirmed, the bank will transfer the funds. This ensures the payment will be made as long as the services are performed. These financial instruments are often used in trade financing when suppliers, or vendors, are purchasing and selling goods to and from overseas customers with whom they don't have established business relationships. The instruments are designed to reduce the risk taken by each party.
Es un convenio que se inicia con la solicitud del comprador (importador-ordenante) a la entidad financiera de poner a disposición del vendedor (exportador-beneficiario) una cierta cantidad de dinero, contra la presentación de determinados documentos previamente convenidos. La entidad de crédito (banco emisor) está garantizando el buen fin de la operación si se cumplen los clausulados del crédito documentario por lo que está actuando de fiador del ordenante ante el beneficiario. Asume el compromiso de pago a la presentación de documentos. Es un producto complejo que presenta multitud de tipologías.
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