“Loan Portfolios and What They Offer”

 

Oftentimes in the field of finance, you will hear about “portfolios.” Generally speaking, they are collections of various financial investments, such as stocks, bonds, commodities, cash, and cash equivalents. In the context of precious metal-backed crypto and other valuable assets, it is not uncommon for the topic of diversification to be tossed around.

 

When it comes to loan portfolios, their definition deviates quite a bit from what we are used to seeing in regards to conventional financial portfolios.

 

What are they?

 

“Loan portfolios” are loan pools that financial institutions and government agencies own and maintain. On a balance sheet, the loan portfolio is identified as an asset because of the recurring revenue that the loan payments generate. A loan portfolio’s value depends on two vital factors: 1) the principal and interest owed, and 2) the loans’ average creditworthiness. However, a loan portfolio could potentially put a business in financial trouble should many borrowers default on their loan payments.

 

A loan portfolio typically holds a specific type of loan, with examples including commercial loans, mortgages, or home equity lines of credit. Portfolio managers acquire loans for the portfolio by way of writing or purchasing loans. In the case of banks, they write mortgages as well as home equity lines of credit.

 

Mortgages are usually sold to investment firms that build portfolios consisting of mortgages purchased from different banks. With that said, banks preserve in-house home equity loans portfolios and utilize the income that these loans generate as a means to fund new home equity loans.

 

Interest Rates and Managing Credits

 

When a portfolio’s loans are paid off or refinanced, the fund manager will use the payoff’s cash proceeds to buy new loans. The interest rates residing on new loans may surpass the rates paid on loans that have been recently paid off. In this case, the revenue that the portfolio produces will increase, but the opposite can also happen and result in a decrease in the revenue.

 

When applying for a loan, the lender will review your credit report and income documentation to figure out your creditworthiness. Obtaining a loan is difficult – if not impossible – if you have bad credit or inadequate income.

 

Loan portfolio managers have established credit management guidelines and only purchase loans written to borrowers who meet them. For commercial loans, borrowers need to requalify for the loan annually. If decreased revenues mean that a company is not meeting the portfolio credit standards, then the lender or portfolio controller can call in the loan. This in turn means that the borrower must repay the debt. However, loan portfolio operators and lenders cannot call in personal loans.

 

Crucial steps for successful portfolio management

 

In order to make the management of loan portfolios effective, lenders must conduct the following:

 

  • Embrace more risk-adjusted return measures.
  • Apply flexibility as a way to attribute enlightened risk ratings.
  • Keep track of the contributions made by each business line to aid the enterprise’s return target.
  • Come up with targets of loan concentration.
  • Work out the options for product line de-risking, exiting, and/or acceleration.