merlin
Minor shareholder in Assetz and many other companies.
Posts: 902 
Likes: 302
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Post by merlin on Nov 7, 2013 20:01:08 GMT
Request for Andrew Holgate to repeat his explanation from the old indie site of how Banking and Finance works in respect of debt/investment. I know that many people browsing the site felt that the explanation was one of the best they have seen and I fully endorse their views. So please Andrew for the benefit of the ignorant or uninitiated, a repeat version please.
AH - I've made this a sticky so it doesn't get lost.
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Post by mead187 on Nov 7, 2013 20:05:49 GMT
Is this the one your referring to? You can still read everything on the old forum its just locked for new posts. Might be an idea to migrate any posts of interest before they get deleted.
EDIT - unless of course its breaches any kind of data laws. Wouldn't want the place shutting down just when its started..
"For every loan they make, banks have to hold back a certain level of cash to cover potential losses as required under the Basel regulations. When RBS went bust it held c5% in cash against the loans it had. Basel 3 requires banks to hold 10%+. Now this is an average figure as some loans are less risky than others. A mortgage at under 50% LTV is less risky than lending on an unsecured overdraft. So banks have a tiered structure they use based on two factors called Probability of Default and the Loss Given Default.
Taking the 50% LTV mortgage, the PD and LGD are low, so the resulting cash they need to hold is low. In the case of the Leeds property we have, then it is a very different story. The PD is high because the level of debt the business has against the affordability means it is at risk of default, or already has defaulted. Plus the debt is £5m against a value of £2.25m, so a loss is also going to be large. In this case the bank may need to hold at least 50% of the loan in cash under the Basel requirements. As a good loan, if it was repaid the cash benefit to the bank is £5m of debt and £500k of risk capital. A total of £5.5m.
As the borrower has had difficulties, the bank will have already made a decision to write off the debt. Taking a reduction will have no effect on the balance sheet of the bank. What will have an effect is what cash it gets back. £1.8m + £2.5m freed up in risk capital. £4.3m in total.
The net effect to the bank is that is has lost £1.2m. Now, let's assume they want to use the £4.3m as the 10% risk capital in the mortgage market. The government Funding for Lending scheme means the banks can borrow the cash at 0.5% but they will lend it out at at least 2% above that. They can borrow £43m from the government, using the £4.3m as the risk capital they need, but make 2% per annum on £43m, which is £860k pa. In 18 months they will have recovered the net £1.2m shortfall.
Does that make sense? It is more complicated that that, but it is a very generalised view."
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merlin
Minor shareholder in Assetz and many other companies.
Posts: 902
Likes: 302
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Post by merlin on Nov 7, 2013 22:55:40 GMT
Is this the one your referring to? You can still read everything on the old forum its just locked for new posts. Might be an idea to migrate any posts of interest before they get deleted. more complicated that that, but it is a very generalised view." Yes this is the one. Many thanks for putting it up here, I am sure many will appreciate it. I guess many of us have other methods for evaluating prospect loans beyond examining all the relevant data provided. In my case I had a close look at the valuation of the Leeds property and made enquiries as to the possibility of a quick resale and the number of properties currently on sale and available to let in the vicinity of the prospect. I was reassured having done this so promptly made a bid. My only concern was that estate agents felt that the market was already recovering from their low point and could begin to rise rapidly well within the time frame of this loan. Thus if this proves to be the case the current owner may chose to remortgage at a lower rate elsewhere before the end of term.
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