Question

A bank has issued a one-year loan commitment of $2 million for an upfront fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The bank’s cost of funds is 7%, and interest on the loan is 9%. The client is expected to withdraw 60% of the commitment at the beginning of the year. What is the expected return on this loan? Discuss the take-down risk on the value of this bank.      

Answer 1

Upfront Fee on the Loan = Upfront Fee rate * Loan Amount = 0.0025 * 20,00,000 = 5,000

unused portion of the commitment = (1 - Commitment percentage) * Loan Amount = ( 1 - 60%) * 20,00,000 = 800,000

Backend Fee on the Loan = Backend Fee Rate * unused portion of the commitment = 0.0010 * 800,000 = 800

Interest fee income = Interest rate * Commitment percentage * Loan Amount = 9% *  60% * 20,00,000 = 108,000

Total Income = Upfront Fee on the Loan + Backend Fee on the Loan + Interest income = 5000 + 800 + 108,000 = 113,800

Funds requiremnet by bank =  Loan Amount =  20,00,000 = 20,00,000

expected return on this loan = Total Income / Funds requiremnet by bank = 113,800 / 20,00,000 = 5.40%

Bank reuire to provide approved loan amount available always. Since if the customer does not avail the approved loan in higher percentage bank will lose opportunity cost of fund. It will reduce banks profitability and Value.