Valuing Installment Loan Receivables

Goebel Paul R. (), Koch Timothy W. () and Macdonald Scott S. ()
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Goebel Paul R.: Department of Finance, Rawls College of Business, Texas Tech University, Lubbock, TX 79409-2101, USA
Koch Timothy W.: Department of Finance, University of South Carolina, Columbia, SC, USA
Macdonald Scott S.: Department of Finance, Southern Methodist University, Dallas, TX, USA

Journal of Business Valuation and Economic Loss Analysis, 2013, vol. 8, issue 1, 71-90

Abstract: Following the recent financial crisis, many banks are finding it increasingly difficult to book earning assets. To this end, many larger organizations are attempting to expand their consumer operations because of their relatively high promised returns. One dramatic move is to focus on the historically under-banked customers who do not have banking relationships. Another is to either create or purchase traditional consumer loan portfolios to achieve higher yields and to potentially transfer these assets to off-balance-sheet vehicles for capital requirement purposes. When purchasing these portfolios, regulatory approval is required, using an approved valuation method. Two alternative methods of valuing a portfolio of small, high-risk, high-overhead expense loans are presented and compared in this article. The first method, one approved by federal bank regulators in private examination cases, uses the accounting principle of valuation of an intangible asset. The present value of identifiable valuables (book value of the loan portfolio in this case) is added to the present value of the unidentifiable valuables (the above average rate of return of the risky cash flows in this case). The second method uses a “certainty equivalent” or “expected value” approach in which the certainty equivalent factors are estimated from historical data. The two methods produce similar but different values of the loan portfolio. The similarities and difference between the two approaches should shed light on the usefulness of the two alternatives in meeting government regulations as well as accurately valuing bank assets.

Keywords: valuation; certainty equivalency (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1515/jbvela-2012-0001

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