Integrated Mini Case LOAN ANALYSIS

As a senior loan officer at MC Bancorp, you have the following loan applications waiting for review. The bank uses Altman's Z score, default probabilities, mortality rates, and RAROC to assess loan acceptability. The bank's cost of equity (the RAROC benchmark) is 9 percent. The bank's loan policy states that the maximum probability of default for loans by type is as follows:

Loan Type and Maturity Maximum Allowable Default Probability

AAA-rated 0.50%

A-rated 1.25

Which loans should be approved, and which rejected?

1. An AAA-rated, one-year CI loan from a firm with a liquidity ratio of 2.15, a debt-to-asset ratio of 45 percent, volatility in earnings of 0.13, and a profit margin of 12 percent. MC Bancorp uses a linear probability model to evaluate AAA-rated loans as follows:

PD = -0.08X1 + 0.15X2 + 1.25X3 - 0.45X4 Where

X1 = Liquidity ratio X2 = Debt-to-asset ratio X3 = Volatility in earnings X4 = Profit margin