Dudley National has issued the following off-balance sheet items:
A one-year loan commitment of $1 million with an up-front fee of 40 basis points. The back-end fee on the unused portion of the commitment is 55 basis points. The bank’s base rate on loans is 8 percent, and loans to this customer carry a risk premium of 2 percent. The bank requires a compensating balance on this loan of 10 percent to be placed in demand deposits and must maintain reserve requirements on demand deposits of 8 percent. The customer is expected to draw down 75 percent of the commitment at the beginning of the year.
A one year loan commitment of $500,00 with an up-front fee of 25 basis points. The back – end fee on the unused portion of the commitment is 30 basis points. Loans to this customer carry a risk premium of 2.5 percent. The bank will not require a compensating balance on the loan. The customer is expected to draw down 90 percent of the commitment at the beginning of the year.
A three-month commercial letter of credit on behalf of one of its AA-rated customers who is planning to import $400,000 worth of goods from Germany. The bank charges an upfront fee of 75 basis points on commercial letters of credit to AA-rated customers.
A standby letter of credit to one of it’s A-rated customers who is planning to issue $5 million of 270-day commercial paper for an effective yield of 5 percent. The corporation expects to save 50 basis points on the interest rate by using the SLC. The bank charges an up-front fee of 40 basis points on SLCs to A-rated customers to back the commercial paper issue.
A. What up-front fees does the bank earn on each of these?
B. What other income does the bank earn on these off-balance-sheet activities?
C. Calculate the returns on each of the off-balance sheet activities assuming that the take downs on the loan commitments are at the expected percentage and the customers holding the letters of credit do not default on their obligations.