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1、A Framework for Credit AnalysisI.Risk AssessmentII.The Clients Funding NeedsIII.Loan Structuring IV.Loan Management 1Credit AnalysisI.Risk AssessmentMonitoring the Economic EnvironmentAnalyzing Industry ConditionsAssessing a Clients Marketing ManagementAppraising the Clients Operations ManagementEva

2、luating Management Capabilities and CharacterAnalyzing the Borrowers Financial Management2Credit AnalysisMonitoring the Economic EnvironmentMuch of the risk associated with a loan is due to broad economic forces as shown on the next slideLender must manage its exposure to certain types of businesses

3、Lender may have to curtail lending, even to businesses with a good track record, in periods of economic adversityNecessary to monitor the current and forecasted economic environment3Credit AnalysisThe Economic Environment - Cont.Key elements of the economyEconomic growth - the business cycleInflatio

4、n ratesInterest rates - the level, term structure and risk structureGovernment - political trends and current fiscal and monetary policiesInternational relationships - balance of payments, currency value, international markets4Credit AnalysisThe Economic Environment - Cont.It is important for the le

5、nding officer to keep on top of broad economic conditions because of their potential impact on the banks clients and the quality of the officers loan portfolio5Credit AnalysisAnalyzing Industry ConditionsA borrowers financial performance depends on: Current conditions and prospects for its industryH

6、ow well the company is positioned relative to the competition?It is necessary to understand both the risks and opportunities for the major industry sectors in the banks marketDetermine two factors:Are the industrys prospects attractive?Which types of firms are most likely to succeed in the industry?

7、6Credit AnalysisAnalyzing Industry ConditionsBanks now create portfolio management groupsMonitor industry concentrations in the banks loan portfolio Determine future prospects for key industriesSet limits on the maximum exposure the bank will permit for an industry or specific borrowerRisk classific

8、ation systems - used to assign a numeric risk rating to all borrowers or loan requests. Industry conditions form part of this risk rating.7Credit AnalysisFactors affecting Industry ConditionsMichael Porters ModelEase of EntryAvailability of Substitute ProductsBargaining power of buyers and suppliers

9、Competitive rivalry. Rivalry tends to be greatest when there are numerous companies producing largely undifferentiated products or services.Dependence on other industries8Credit AnalysisAssessing a Clients MarketingMarketing is a critical factor for most borrowers, especially “start-ups”, those ente

10、ring a new business or facing tough competitionFirm should have a plan which covers:Product PoliciesPrice PoliciesPromotionPersonal Selling ActivitiesDistribution Policies9Credit AnalysisAppraising the Clients Operations ManagementOperations management - the set of activities required to transform i

11、nputs such as raw material and labour into the final product. Major components of operations include:Quality - value for moneyProcess Design - technology, plant layoutFacilities Planning and SchedulingInventory Management - how much is necessary to carry?Employee management 10Credit AnalysisEvaluati

12、ng Management Capabilities and CharacterDetermine the experience and skills of key principalsThis includes technical knowledge, contacts, resources in marketing, operations and finance plus skill in managing and motivating othersAssess managements character: integrity, financial conservatism and res

13、pect for creditors11Credit AnalysisAnalyzing the Borrowers Financial ManagementStrong financial management is an essential ingredient for successFinancial capacity is the composite of management policies and practices in several areas:Is there adequate liquidity?The firms relationships with trade cr

14、editors, lenders and investorsThe equity capital contributed by the ownersThe extent of the owners withdrawals12Credit AnalysisBorrowers Financial Management contd Calculate key financial ratios1.Profitability ratios2.Asset utilization ratios3.Financial capacity testsWhich ratios to calculate will v

15、ary with the the industry and type of business (example - service or manufacturing)13Credit AnalysisProfitability RatiosProfit Margin: Net profit after tax/net sales. Gross Profit margin: The portion of revenues remaining after the cost of sales. (Net Sales - Cost of Sales)/ Net SalesSales Growth: M

16、easured over time. Usually expressed as a % growth per year.Return on Assets: Net Profit/Total Assets. This may be distorted due to the age of the firms assets.14Credit AnalysisProfitability RatiosReturn on Equity = Net Profit/Total EquityThis measures the rate of return on the capital provided by e

17、quity investors. Equity includes common stock, retained earnings, and minority shareholders interestBanks normally require an agreement from the owners that equity funds will not be withdrawn without the banks prior permission15Credit AnalysisAsset Management RatiosTurnover of Current Assets. Days o

18、f inventory = Inventory/(Cost of Sales365 days). This shows how carefully management is controlling its investment in inventory. Cost of sales is used to ensure that both goods sold and inventories are compared on the same basis, namely at the cost of purchase or production. 16Credit AnalysisAsset M

19、anagement RatiosCollection period for Receivables = Accounts Receivable/(Net Credit sales365)Tells us how quickly Accounts Receivables are collectedIn addition, the lender should obtain an aging schedule which classifies Accounts Receivable by how long they have been outstanding For example, if the

20、business sells on net 30 days then most receivables should be no longer than 30 days17Credit AnalysisTypical Aged Accounts Receivable Schedule0-30 days31-6061-9090+Grade A Company Inc12,000A Good Bet & Associates23,000Not So Bad Co.4,500A Poor Deal Inc.6,000Fly by Night Ltd.99918Credit AnalysisAsset

21、 Management ratio - contdIf a large number of customers have not paid for 40 or 50 days or longer, then the company may be lax in collecting overdue accounts or has extended credit to customers who have difficulty paying.Older receivables may indicate that the quality of the receivables is suspect.

22、This means that the bank may not be able to collect all of its receivables if the borrowers assets needed to be liquidated.19Credit AnalysisFinancial Capacity RatiosThe firm must be sufficiently liquid to meet its recurring commitments and have a debt structure that can be serviced from both its pro

23、fits and its cash flowsLiquidity Measures:Current Ratio = Current Assets/ Current LiabilitiesIs a good measure of solvency as it indicates the extent to which claims of short-term creditors can be covered by liquid assets20Credit AnalysisFinancial Capacity Ratios Quick ratio = (Cash+Short Term secur

24、ities + receivables)/ Current LiabilitiesShows the most liquid assets which can be liquidated to meet short-term obligations21Credit AnalysisFinancial Capacity RatiosDebt Ratios tell us how much financial leverage the firm has. Higher leverage increases the risk of the loan and whether the firm will

25、 be able to service its interest and principal payments.The amount of equity invested signals the commitment of the major shareholders to the business.22Credit AnalysisFinancial Capacity Ratios ContinuedDebt to Assets = (Current Liabilities + Long-term debt) Assets* Measures the proportion of assets

26、 financed by other peoples money including the bank.Debt to Equity = (Current Liabilities + long-term debt) (Total equity capital + postponed shareholders loans)* Measures the debt relative to the investment of the owners.Interest Coverage Ratio = (Earnings before interest and taxes)/ interest. * Th

27、is measures a firms debt-worthiness and its ability to meet interest payments out of recurring profit.23Credit AnalysisSummary of Financial Ratio AnalysisProfitability Ratios:Net Profit MarginNet Profit/SalesGross Profit MarginGross Profit/SalesReturn on AssetsNet Profit/ SalesReturn on EquityNet Pr

28、ofit/EquityAsset Management Ratios:Total Assets TurnoverNet Sales/Total AssetsFixed Assets TurnoverNet Sales/Net Fixed AssetsDays of InventoryInventory/(Cost of Sales365)24Credit AnalysisFinancial Ratios ContinuedAccounts ReceivableCollection PeriodAccounts Receivable (Average Daily Sales)Financial

29、Capacity Ratios:Current ratioCurrent Assets/ Current LiabilitiesQuick ratio(Current Assets less inventory less prepaid expenses)/ Current liabilities25Credit AnalysisFinancial Ratios ContinuedFinancial Capacity Ratios (Continued):Accounts payable payment period = Accounts payable/ Average daily purc

30、hasesDebt to assets ratio = Total Debt/Total AssetsInterest Coverage = (Earnings before interest and taxes) Interest26Credit AnalysisCash Flow AnalysisThe purpose of a risk assessment is to judge the companys ability to service its obligations to the bank.A borrowers repayment capacity is primarily

31、determined by the cash flows that the business generatesThe major sources and uses of cash in the business must be identified to predict future cash flowsStatement of changes in financial position are provided as part of the cash flow statements Tells where the cash is coming from and where it is be

32、ing used: operating, investing and financing activities27Credit AnalysisII. The Clients Funding NeedsEstimating Total Financing NeedsIdentifying Non-Bank Sources of Financing28Credit AnalysisEstimating Total Financing NeedsA banker has to identify the total funding that the company requires to suppo

33、rt its current operations and to carry out its plans for expansion.The major methods of forecasting a firms financial needsCash Flow budgetsPro forma financial statementsThe loan facility must be set at a level that is both realistic for the companys needs but is not excessive relative to the availa

34、ble cash flows29Credit AnalysisFinancing NeedsFinancial forecasts must be prepared by management or an outside accountant and the banker can only assess the reasonableness of the forecasts.Provides both the amount and timing of the firms needsHelps the banker better analyze the risks associated with

35、 a loan request.Sensitivity analysis should be done where the forecasts are prepared using different assumptions about future events30Credit AnalysisFinancing NeedsBankers too often see loan applications only after financial needs have become immediate and urgent.Financial forecasts provide the bank

36、 with checkpoints for monitoring a borrowers progress and performance.An unanticipated need is not necessarily bad. It could also indicate that the firm has found a new business opportunity to pursue.31Credit AnalysisCash Flow ForecastsCash flow forecast estimates when and in what amounts cash will

37、flow in and out of the businessCash budgets are useful for short term forecasts and for those companies with seasonal sales and production cyclesPrepare Cash Receipts based on projected sales and then prepare cash outlays which are closely linked to the sales forecast.32Credit AnalysisSample Cash Bu

38、dget33Credit AnalysisProjected Financial StatementsApproximate forecasts can be developed by applying the companys existing balance sheet and income statement ratios to estimates of future sales volumes.Extend forecasts several years into the futureForecasted Income StatementsAre usually the startin

39、g point in developing a pro forma statementMany variables such as inventories & account s receivables move closely with sales34Credit AnalysisProjected Financial StatementsStart with forecasting the estimated sales growth rate. Raw material costs, labour expenses and production supplies as a percent

40、age of sales are forecasted to remain at current levels. Usually the balance sheet is more difficult to forecast than an income statementEstimates are required and may not be related to a single key variable such as the sales figure35Credit AnalysisProjected Financial StatementsAccounts receivable a

41、nd inventory are tied to sales Estimate the accounts receivable balance based on the past collection experienceEstimate inventories based on the typical inventory levels.Estimate the planned purchase of new plant and equipment less depreciationAccounts payable forecast should incorporate the company

42、s planned purchases of raw materials and its payment practices36Credit AnalysisProjected Financial StatementsCash and Notes payable should be adjusted to balance both sides of the balance sheet. Cash account is set at an amount that the company believes to be a reasonable working balance. Once the c

43、ash account is forecasted, the bank loan payable can be calculated to find the amount that makes the balance sheet balance. This is known as the “plug” figure.This balancing figure represents the clients funding requirement to support the forecasted level of assets.37Credit AnalysisProjected Financi

44、al StatementsForecasts should be constructed with different basic assumptions.Sensitivity analysis could test the following:1.Slowdown in the collection of accounts receivable2.Decline in inventory turnover rate3.Unanticipated expansion of fixed assets4.Higher expenses than planned5. Lower sales lev

45、els than predicted6.Trade creditors demanding faster payment38Credit AnalysisIdentifying Non-Bank Sources of FinancingThree broad sources of funds are available to the firm:1.Funds generated by the firm by increasing the working capita.lA. Shorten credit terms and increase the quality of customers r

46、eceiving credit (use better screening). B.Reduce company inventory levels and slow paymentof account payables (where possible)C.Improve financial planning - cash flow budgeting 39Credit AnalysisIdentifying Non-Bank Sources of Financing2.External business sources - Personal AssetsFriends, family and

47、employees - “l(fā)ove money”Informal Investors - private individualsFactoring - a firm that acts as the credit and collections departmentLeasingFranchising or Venture CapitalOther term lenders - eg. GE CapitalPublic Equity Markets40Credit AnalysisIdentifying Non-Bank Sources of Financing3.External gover

48、nment SourcesGrantsForgivable LoansDirect loansGovernment GuaranteesTax breaksDirect equity investments in the firm41Credit AnalysisPart III. Loan Structuring1.Identifying the Amount and Form of Bank Financing2.Lending and the Legal Environment3.Securing the Loan4.Lending and Environmental Law5. Pri

49、cing the Loan 6. Designing the loan agreement and loan covenants42Credit AnalysisThe Amount and Form of Bank FinancingThe Initial Screen -Is the deal “bankable?”. Does it have acceptable risks relative to the return? Is the return adequate to compensate for the risks accumulated and the cost of serv

50、icing the account.Banks are in the business of granting loans that they consider to be relatively low risk.Prepare a list of pros and cons Turning down the loan should include a frank discussion of the companys problems and options43Credit AnalysisThe Amount and Form of Bank FinancingSetting the loa

51、n limitDetermine the clients ability to pay Cash flows are derived from internally generated funds. Long-term loans can only be repaid from profits if the business is to remain a viable entity.Enforced liquidation of the companys assets is a “fall-back” position, should cash flows from operations fa

52、ll short of requirementsInjection of owners capital - is it available if needed?Collateral security - determine the lending value of accounts receivable and inventory or the value of the fixed assets44Credit AnalysisThe Amount and Form of Bank FinancingBanks normally finance 75 to 80 percent of the

53、cost of fixed assets100% financing may be warranted if the assets could be readily sold at their purchase price or if the customer has additional collateral to support the loanThe amount of the loan should be sufficient to meet the customers financial needs45Credit AnalysisThe Amount and Form of Ban

54、k FinancingThe Repayment TermThe term of the loan is the time period during which the loan payments are fixed.The amortization period is the period over which the loan is scheduled to be repaid. For example, someone purchasing a house may have a mortgage with a term of 5 years but amortized over 25

55、years.Repayment period depends on what the money is being used forTransaction loans are for temporary funding - eg. a bridge loan46Credit AnalysisThe Amount and Form of Bank FinancingOperating loans (floating prime based loans) are used to finance a companys accounts receivable and inventory and flu

56、ctuate as the firm moves through different selling seasonsLetter of credit - says that the bank will pay a certain sum on the delivery of specific documents to the bank. They are commonly used for international trade. When the bank pays, they will then require payment from the borrowerTerm loans - u

57、sed to buy specific fixed assets and will be paid out over time from the cash flows the asset generates47Credit AnalysisLending and the Legal EnvironmentA secured creditor is one with specific legal rights against particular assets of the debtor which may be exercised, should the debtor fail to fulf

58、ill promises given to the creditorAn unsecured creditor is anyone to whom the debtor owes money - the unsecured creditor has no specific rights against the debtors property, other than the general right to sue for enforcement of the debtors promise to pay.A basic understanding of the legal system is

59、 essential to those making decisions on commercial credit48Credit AnalysisSecuring the LoanRole of collateral security involves 3 tasksDetermine available assets that could be pledged as collateral and estimate their net realizable value as a secondary source of repayment.Be knowledgeable of the pro

60、cedures for documenting and registering a security interest to ensure that the banks interest are protectedMonitor the borrowers collateral position over time49Credit AnalysisLending and Environmental LawLegislation may increase default risk in several waysLegislation which restricts how a borrower