Credit Management Chap 8

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  • 1. Prepared by John Anderson,Queensland University of Technology
  • 2. Chapter EightCorporate Lending 2
  • 3. Learning Objectives• Apply the principles of corporate lending• Explain the application of lending criteria• List the contents of the loan structuring proposal 3
  • 4. Learning Objectives• Discuss the importance of financial information• Explain the importance of managing the loan portfolio• Demonstrate awareness of available loan products 4
  • 5. Introduction• Corporate lending is still more of an art than a science• Credit scoring techniques still being developed, although a percentage of loans will still go bad• The lifecycle of loans highlights differences between lending and corporate entities 5
  • 6. An Overview of Corporate Lending• Many issues in corporate lending – High end of the portfolio mix – Fiercely competitive – Potential overexposure to segment – Must carefully follow lending criteria as principles of lending still apply – When taking risks, occasional losses are not only likely, but expected 6
  • 7. The Purpose of Corporate Lending• Aim is to grow loan book in a way that maximises shareholder wealth – The Loan Portfolio • Should contain a good mix of interest rates, cashflows and maturities including: – Diversification of asset mix, geographical composition and loan types – Expertise of staff in market segments, policy, competition elements, environmental issues (e.g. economic, demographic) and accept delegation – Appropriate loans audit and review 7
  • 8. The Principles of Corporate Lending• Lending is a risk/reward trade-off; must manage those risks well – Encourages corporations to include ‘hurt money’ as first source of funding 8
  • 9. The Principles of Corporate Lending– Three Overarching Principles • Safety – Ability to repay the loan • Suitability – Purpose and amount of loan, hurt money and repayment schedule • Profitability – Sufficient return on investment 9
  • 10. The Principles of Corporate Lending• Methods of lending assessment – Two key methods applied, namely the 5 Cs and PARSER approaches 10
  • 11. The Principles of Corporate Lending– 5 Cs • Character – The character of a corporation very important – How was company set up and by whom? – What is the reputation of the company and its management? – Does management have a good relationship with its bankers and stakeholders? 11
  • 12. The Principles of Corporate Lending• Capacity – Lender should consider not just the capacity to service the loan but also the capacity to borrow• Collateral – Borrower must demonstrate commitment to the project and also provide ways out for lender 12
  • 13. The Principles of Corporate Lending• Conditions – Lender must consider internal and external forces likely to affect the project• Capital – Requires careful analysis of company’s financials 13
  • 14. The Principles of Corporate Lending– PARSER • Personal Element – Assesses the integrity, culture and ethics of the firm and its board • Amount Required – Is amount sufficient for the proposed purpose? • Repayment – Should not be based solely on cashflows – Need to consider trend analysis, detailed cashflow projections and alternative repayment options considering the turnover of the firm 14
  • 15. The Principles of Corporate Lending• Security – Assets supporting the loan representing a second or third way out for the lender• Expedience – How does opportunity fit into the funding and target market segments of the lender?• Remuneration – Does the loan fit well with the credit criteria determined by the credit committee? – How profitable is the loan given the interest rate, application fees, commitment fees, etc? 15
  • 16. The Principles of Corporate Lending• The Lending Cycle – Covers the birth (loan approval) to death (repayment) of the loan – Contains three key elements • 1 – Origination • 2 – Funding • 3 – Managing – These elements may be further refined 16
  • 17. The Principles of Corporate Lending• Identification/exploitation of target markets• Success of origination depends on finding clients and delivering the right products• Evaluating proposals via credit analysis• Successfully negotiating terms/conditions• Advising loan applicant of success/failure• Preparation and exchange of documents• Disbursement of funds• Loan administration and review• Determining if payments received on time 17
  • 18. The Principles of Corporate Lending– Should loan not perform • Prior planning should provide strategies to quickly handle adverse credit events • If remedial actions fail, appropriate courses of action must be determined • Workout Situation – Can alternatives lead to increased recovery such as change repayment arrangements, exercise of liens over property, etc? • Write-off outstanding amounts 18
  • 19. The Principles of Corporate Lending– Structuring the Loan Proposal • It should address the following questions – Is loan amount sufficient for task? – Is cash available and repayment identifiable? – Is term of debt long (>12 months) or short-term? 19
  • 20. The Principles ofCorporate Lending– If long-term, will cashflow projections support repayment and does purpose match term?– If short-term, does asset conversion cycle and working capital allow repayment?– Does the borrower have seasonal funding requirements of is it ‘hard-core’ debt? 20
  • 21. The Principles of Corporate Lending– Small Corporate Entities • Market segmented according to turnover, employee numbers, etc. • Many have unaudited financial statements and financials must be treated with caution– Large Corporate Entities • Different banking relationship due to direct access to global capital markets • Requires more innovative solutions to enhance corporate financing activities 21
  • 22. The Principles of Corporate Lending– Product Structure and Application • Popular high-end products include – Revolving Credit: Flexible facility with a limit that may be drawn, repaid and used again – Standby Lines: Funds that may be drawn down when required with guaranteed access 22
  • 23. The Principles ofCorporate Lending– Revolving Underwriting Facilities: Funds available on demand and reinstated on repayment– Syndicated Facilities: Mixture of product offerings shared by multiple lending firms– Project Finance: Specific funding for single large-scale projects 23
  • 24. The Principles of Corporate Lending– Project Finance Characteristics • Project is distinct financial entity • Project often highly geared (75% debt) • Loans linked directly to project’s assets and cashflows • Sponsor’s guarantees expire with project • End-users and suppliers may provide credit • Lender’s recourse limited to project’s assets • Finance generally longer-term 24
  • 25. Credit Rating Agencies• Credit rating is a formal credit opinion provided by rating agency for financial markets• Generally for large corporates and sovereign borrowers• Ratings used in conjunction with other credit criteria 25
  • 26. Skills Required of the Loan Officer• Appropriate skill set includes • Understanding loan portfolio complexity • Subjective and objective in risk assessment • Sound credit administration and record- keeping • Strong focus on loan monitoring and credit judgment • Technologically competent • Clear thinker who is good at early problem recognition and decisive solution-finding 26
  • 27. The Importance of Financial Statements• Accounting, as with lending, is something of an art – Behind the numbers lie key questions • Are financial statements and cashflow projections reliable? • Are cashflows sufficient to sustain operations and ultimately repay debt? • Will cashflows allow repayments to occur when required under loan agreement? 27
  • 28. Managing the Loan Portfolio• What can go wrong? • 30% of bad loans were unsound when loan made – facts missed or analysis was faulty • Much greater risk of errors in loan approval process than fraud • Risks are – External: Changes to regulations/legislation, technological, globalisation, economic, etc. – Internal: Poor planning, organisation, profit planning/cost control and resource management 28
  • 29. Advice from the Past• What are some of the key lessons from experienced credit managers? • Always try to work in a team for credit decisions • Allow sufficient time for reasoned decisions • Verify ALL facts and figures • Segregate the selling and approval of loans • Be firm with the client and don’t be forced into bad decisions 29
  • 30. Advice from the Past• Never promise what you cannot deliver• Always consider client’s quantitative AND qualitative aspects• Volume is not necessarily profit. The client must also add to profitability• The purpose of the loan should also indicate the repayment ability• Visiting client’s firms adds to your understanding and allows business creation 30
  • 31. Advice from the Past• Record all relevant facts as soon as possible, and not from memory, as files may become evidence• Try to confine client dealings to professional matters only• Timely and careful gathering of information• Be proactive, not lazy and reactive• All loans should provide at least two ways out – cashflows and security 31
  • 32. 32