Fundamentals of Business

Loan capital

Loan capital this consists of loans, debentures and mortgages. Loans (bank credit) Written or oral agreement for a temporary transfer of a property (usually cash) from its owner (the lender) to a borrower who promises to return it according to the terms of the agreement, usually with interest for its use.

If the loan is repayable on the demand of the lender, it is called a demand loan. If repayable in equal monthly payments, it is an instalments loan. If repayable in lump sum on the loan's maturity (expiration) date, it is a time loan. Banks further classify their loans into other categories such as consumer, commercial, and industrial loans, construction and mortgage loans, and secured and unsecured loans.

Banking relationship Lending covenant Before the bank issue you credit, they do credit checks, this is to ensure you are creditworthy, that is you can afford to pay back. The affordability measure is known as interest cover. Interest cover = profit before interest/interest payable If interest cover fall to a certain level, usually 2.5 times (that means interest is 40% of profit), the loans has to be renegotiated or settled.

Example of a renegotiated loan An extract from Bloomberg

Taylor in Talks to Raise Funds, Amends Loan Covenants (Update1) By Scott Hamilton June 30 (Bloomberg) - Taylor Wimpey Plc, reeling from the U.K.'s worst housing slump in almost three decades, plans to raise money from investors after writing down the value of land by 660 million pounds ($1.32 billion). The homebuilder, based in London, renegotiated loan covenants in response to a "weak" housing market, Taylor said today in a statement, without identifying the parties involved in the talks. Standard Life Plc and Legal&General Group Plc are among a group of investors to supply as much as 500 million pounds, according to the Sunday Telegraph. The company, created in the 4.3 billion-pound merger of Taylor Woodrow and George Wimpey last year, has dropped 83 percent in London trading in 12 months. U.K. home loan approvals fell 56 percent last month, the most since at least 1997, as banks curtailed lending in response to subprime losses. That's stifled home buying and Taylor Wimpey said on April 17 that sales had dropped "significantly".

Consequences of selling to people with poor credit rating Example Extract from bbc·co·uk

The US sub-prime crisis The US sub-prime mortgage crisis has lead to plunging property prices, a slowdown in the US economy, and billions in losses by banks.

HOW SUB-PRIME LENDING AFFECTED ONE CITY

For many years, Cleveland was the sub-prime capital of America. It was a poor, working class city, hit hard by the decline of manufacturing and sharply divided along racial lines. Mortgage brokers focused their efforts by selling sub-prime mortgages in working class black areas where many people had achieved home ownership.

They told them that they could get cash by refinancing their homes, but often neglected to properly explain that the new subprime mortgages would "reset" after 2 years at double the interest rate. The result was a wave of repossessions that blighted neighbourhoods across the city and the inner suburbs. By late 2007, one in ten homes in Cleveland had been repossessed and Deutsche Bank Trust, acting on behalf of bondholders.

Debentures
A security that is a written acknowledgement of a debt incurred by a joint-stock company. It provides for repayment of the debt with a fixed interest. A debenture may be one of the following kinds: A simple unsecured or naked debenture so called because the holder has no lien or pledge on any assets of the company and ranks after secured creditors for payment in the event of liquidation. A debenture having a fixed charge on specified assets
Example
Property stock-holders are entitled to interest and repayment of the loan out of the sale of these assets should it be necessary. Convertible debentures and loan stock such issues may be made when a company needs to raise capital when rates of interest are high.
Mortgage
is similar to debenture in that it is a loan secured by assets of the borrower, but it differs in that, it is a debt to a single lender, the mortgagee.