First Security National Bank has been approached by a long-standing customer, United Safeco Industries, for a $30 million term loan for five years to purchase new stamping machines that would further automate the company’s assembly line in the manufacture of metal toys and containers. The company also plans to use at least half the loan proceeds to facilitate its buyout of Calem Corp., which imports and partially assembles video recorders and cameras. Additional funds for the buyout will come from a corporate bond issue that will be underwritten by an investment banking firm not affiliated with First Security.
The problem the bank’s commercial credit division faces in assessing this customer’s loan request is a management decision reached several weeks ago that the bank should gradually work down its leveraged buyout loan portfolio due to a significant rise in nonperforming credits. Moreover, the prospect of sharply higher interest rates has caused the bank to revamp its loan policy toward more short-term loans (under one year) and fewer term (over one year) loans. Senior management has indicated it will no longer approve loans that require a commitment of the bank’s resources beyond a term of three years, except in special cases.
Does First Security have any service option in the form of off-balance-sheet instruments that could help this customer while avoiding committing $30 million in reserves for a five-year loan? What would you recommend that management do to keep United Safeco happy with its current banking relationship? Could First Security earn any fee income if it pursued your idea?
Suppose the current interest rate on Eurodollar deposits (three-month maturities) in London is 3.40 percent, while Federal funds and six-month CDs are trading in the United States at 3.57 percent and 3.19 percent, respectively. Term loans to comparable quality corporate borrowers are trading at one-eighth to one-quarter percentage point above the three-month Eurodollar rate or one-quarter to one-half point over the secondary-market CD rate. Is there a way First Security could earn at least as much fee income by providing United Safeco with support services as it could from making the loan the company has asked for (after all loan costs are taken into account)? Please explain how the customer could benefit even if the bank does not make the loan requested.