Asset Based Lending:  Back To Basics
The 2007 – 2008 Credit Crises
THE FDIC SPEAKS “ A decline in loan underwriting standards belongs on any list of the factors responsible for the current ...
THE FDIC SPEAKS <ul><li>Issues Contributing to the Credit Crises : </li></ul><ul><ul><li>Competitive relaxation of credit ...
G-20 Leaders Summit  November 15, 2008 “Declaration of the Summit on Financial Markets and the World Economy” “ During a p...
CFA Leaders Recommend Return to Credit Basics   <ul><li>David J. Kantes, Senior Vice President and Chief Risk Officer, Sie...
CFA Leaders Recommend Return to Credit Basics   <ul><li>Michael D. Sharkey, President of Cole Taylor Business Capital - </...
<ul><li>John Kiefer, CEO, First Capital - </li></ul><ul><ul><li>“ Although times may have changed and credits have become ...
What are the Basics? Asset Based Lending:  Back To Basics
Lessons Learned   <ul><ul><li>Underwrite as if you are going to hold the entire deal   </li></ul></ul><ul><ul><li>Know you...
Core Principle of Commercial Lending  Customer Needs Protect Our Assets
Credit Culture <ul><li>There is understanding and respect for the credit basics. </li></ul><ul><li>There is accountability...
Basic Steps of Commercial Lending   <ul><li>Understand the Request </li></ul><ul><li>Gather Information to: </li></ul><ul>...
Back to Basics Four W’s and How <ul><li>WHO -  is the borrower? </li></ul><ul><li>WHAT -  is the deal? </li></ul><ul><li>W...
Back to Basics The Five “C’s” of Credit <ul><li>Management, Management, Management </li></ul><ul><ul><li>Character </li></...
Back to Basics The Five “C’s” of Credit <ul><li>Character </li></ul><ul><li>How do we Measure Character?   </li></ul><ul><...
Back to Basics The Five “C’s” of Credit <ul><li>Capacity </li></ul><ul><li>Ability of the borrower to operate the business...
Back to Basics The Five “C’s” of Credit <ul><li>Capital </li></ul><ul><li>Adequacy of funds needed by the business to allo...
Back to Basics The Five “C’s” of Credit <ul><li>Conditions </li></ul><ul><li>The economic and environmental influences on ...
Back to Basics The Five “C’s” of Credit <ul><li>Collateral </li></ul><ul><li>The property pledged by a borrower to protect...
Wait… Covenants <ul><li>Return to the use of maintenance covenants </li></ul><ul><ul><ul><li>Fixed Charge Coverage </li></...
Some More Basics   <ul><ul><li>Greater scrutiny with respect to add-on acquisitions </li></ul></ul><ul><ul><li>Need to foc...
Asset Based Lending:  <ul><li>Commercial Finance Association:   https://www.cfa.com </li></ul><ul><li>Risk Management Asso...
<ul><li>Norman Smith </li></ul><ul><li>Vice President </li></ul><ul><li>Manager-ABL Underwriting  </li></ul><ul><li>Mount ...
<ul><li>Ira Kreft </li></ul><ul><li>Managing Director &  Region Manager </li></ul><ul><li>RBS Business Capital </li></ul><...
<ul><li>Visit CFA’s Group on www.Linkedin.com </li></ul>
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CFA Credit Basics

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  • Deputy Director French also had this warning for regulated institutions: Over the years, the banking agencies have issued a number of supervisory guidance documents regarding adverse credit risk trends. These guidance documents indicate that the agencies were generally aware of, and concerned about, emerging potential credit risks. A future focus of supervision in responding to such emerging risks may well include a careful look at where the line should be drawn between guidance and informal supervisory expectations on the one hand, and more tangible requirements on the other. Ignore this FDIC warning at your own risk – - Cease and Desist Orders, other negative regulatory consequences for the institution
  • Any commercial bank , and even traditionally non-bank lenders that opted to change to bank holding company status during the recent crisis, should consider the FDIC an important constituency. The FDIC issues numerous …….. Supervisory Highlights is published periodically by the FDIC and contains several articles intended to promote best practices of bank supervision, and thereby, bank management. Following is an excerpt from the introduction to the Summer 2009 issue: In the annals of bank supervision, 2008 will be remembered as a year in which some old assumptions were shattered and some old truths relearned. Some of the old banking basics— prudent loan underwriting, strong capital and liquidity, and the fair treatment of customers—re-emerged as likely cornerstones of a more stable financial system in the future. Comments from George French, Deputy Director, FDIC Division of Supervision and Consumer Protection A look back on the buildup to the financial crisis reveals similarities to earlier cycles of boom and bust. During the expansion, financial firms engage in a competitive relaxation of credit standards and risk tolerances to gain and maintain revenue growth. Easy credit allows borrowers to refinance ever-greater obligations in lieu of repayment, driving down default rates. This fuels the perception that credit risk is minimal, stimulating further loosening of credit terms in a self-perpetuating cycle. To some banks operating in such an environment, traditional lending standards can appear an unnecessary impediment to revenue growth. To varying degrees, subprime mortgages, other consumer loans, construction loans, loans to leveraged corporate borrowers, and commercial real estate loans, have all exhibited weakness in underwriting standards. Underwriting weaknesses have contributed to investor uncertainty about the quality of bank assets and amplified the adverse impact of the economic downturn on bank performance. A decline in loan underwriting standards belongs on any list of the factors responsible for the current crisis.
  • The Office of the Comptroller of the Currency (OCC) conducted its 15th annual underwriting survey to identify trends in lending standards and credit risk for the most common types of commercial and retail credit offered by national banks. The survey covers the 12-month period ending March 31, 2009. This is the most recent survey available. The 2009 survey includes examiner assessments of credit underwriting standards at the 59 largest national banks with assets of $3 billion or more. This population covers loans totaling $3.6 trillion as of December 2008, approximately 84 percent of total loans in the national banking system.
  • Three C’s of Credit – Character, Capital and Capacity
  • Transcript of "CFA Credit Basics"

    1. 1. Asset Based Lending: Back To Basics
    2. 2. The 2007 – 2008 Credit Crises
    3. 3. THE FDIC SPEAKS “ A decline in loan underwriting standards belongs on any list of the factors responsible for the current crisis.” Summary of comments from George French, Deputy Director of Supervision and Consumer Protection in, FDIC Supervisory Insights, Summer 2009, Vol. 6, Issue 1
    4. 4. THE FDIC SPEAKS <ul><li>Issues Contributing to the Credit Crises : </li></ul><ul><ul><li>Competitive relaxation of credit standards to gain and maintain revenue growth. </li></ul></ul><ul><ul><li>Traditional lending standards can appear an unnecessary impediment to revenue growth. </li></ul></ul>Summary of comments from George French, Deputy Director of Supervision and Consumer Protection in, FDIC Supervisory Insights, Summer 2009, Vol. 6, Issue 1
    5. 5. G-20 Leaders Summit November 15, 2008 “Declaration of the Summit on Financial Markets and the World Economy” “ During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system.”
    6. 6. CFA Leaders Recommend Return to Credit Basics <ul><li>David J. Kantes, Senior Vice President and Chief Risk Officer, Siemens Financial Services, Inc. - </li></ul><ul><ul><li>“ Faced with perhaps the worst recession since the 1930s, ‘secured lenders’ are again relearning the lessons from the past 65 + years.” </li></ul></ul>(Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )
    7. 7. CFA Leaders Recommend Return to Credit Basics <ul><li>Michael D. Sharkey, President of Cole Taylor Business Capital - </li></ul><ul><ul><li>“ Once again sound ABL fundamentals and execution will be key to a successful outcome.” </li></ul></ul>(Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )
    8. 8. <ul><li>John Kiefer, CEO, First Capital - </li></ul><ul><ul><li>“ Although times may have changed and credits have become much more complicated and complex, the principles and fundamentals of credit analysis basically boil down to the three C’s of credit analysis, which have served me throughout good times and bad.” </li></ul></ul>CFA Leaders Recommend Return to Credit Basics (Remarks from the 2009 CFA Annual Convention, Education Panel: Asset-Based Lending: How Can the Lessons We Have Learned in the Past be Applied to Today’s Challenges? [ http://www.cfa.com ] )
    9. 9. What are the Basics? Asset Based Lending: Back To Basics
    10. 10. Lessons Learned <ul><ul><li>Underwrite as if you are going to hold the entire deal </li></ul></ul><ul><ul><li>Know your Counterparties and Loan Participants </li></ul></ul><ul><ul><li>Fully understand (meaning underwrite) the risk of credits you buy into </li></ul></ul><ul><ul><li>Make loans that can be repaid </li></ul></ul><ul><ul><li>Require Equity </li></ul></ul>
    11. 11. Core Principle of Commercial Lending Customer Needs Protect Our Assets
    12. 12. Credit Culture <ul><li>There is understanding and respect for the credit basics. </li></ul><ul><li>There is accountability for decisions at all levels. </li></ul><ul><li>A common credit language is spoken throughout the bank, with candor and good communication at every level. </li></ul><ul><li>Each lending officer understands what the bank expects and is aware of the effect of his or her credit decisions on the entire organization. </li></ul><ul><li>The credit system has checks and balances to give early warning of deviations. </li></ul><ul><li>There is flexibility, but not looseness, in dealing with exceptions to policy. </li></ul><ul><li>Concern for the continued health and success of the institution is placed ahead of profit center concerns. </li></ul><ul><li>The incentive system takes into account long-term results, not just immediate profits. Bonuses don’t drive people in wrong directions. </li></ul><ul><li>Source: Mueller, P. Henry, “Trees Don’t Grow to Heaven”, The RMA Journal , December 2008 – January 2009, 53-59 </li></ul>
    13. 13. Basic Steps of Commercial Lending <ul><li>Understand the Request </li></ul><ul><li>Gather Information to: </li></ul><ul><ul><li>Identify The Risks </li></ul></ul><ul><ul><li>Quantify The Risks </li></ul></ul><ul><ul><li>Evaluate The Probability And Impact That We May Take A Loss </li></ul></ul><ul><ul><li>Mitigate The Risks </li></ul></ul><ul><li>Implement The Structure </li></ul><ul><ul><li>Documents </li></ul></ul><ul><ul><li>Portfolio Management </li></ul></ul>
    14. 14. Back to Basics Four W’s and How <ul><li>WHO - is the borrower? </li></ul><ul><li>WHAT - is the deal? </li></ul><ul><li>WHERE - do they operate? </li></ul><ul><li>- where is the project or acquisition? </li></ul><ul><li>WHY - do they need our money? </li></ul><ul><li>- are they expanding? </li></ul><ul><li>- are they making this acquisition? </li></ul><ul><li>HOW - will we get repaid? </li></ul>
    15. 15. Back to Basics The Five “C’s” of Credit <ul><li>Management, Management, Management </li></ul><ul><ul><li>Character </li></ul></ul><ul><ul><li>Capacity </li></ul></ul>
    16. 16. Back to Basics The Five “C’s” of Credit <ul><li>Character </li></ul><ul><li>How do we Measure Character? </li></ul><ul><li>Know Your Customer (KYC)? </li></ul><ul><li>How about “know your customer”? </li></ul><ul><li>Character is tested by management’s ability to successfully navigate cash shortages, hard times, and poor business conditions. </li></ul><ul><li>That intangible, “gut” feeling. </li></ul>
    17. 17. Back to Basics The Five “C’s” of Credit <ul><li>Capacity </li></ul><ul><li>Ability of the borrower to operate the business successfully, to generate the cash needed to repay obligations. </li></ul><ul><li>How do we measure Capacity? </li></ul><ul><ul><li>Financial Statements </li></ul></ul><ul><ul><li>Projections </li></ul></ul><ul><ul><li>Trade References </li></ul></ul><ul><ul><li>Financial Covenants </li></ul></ul>
    18. 18. Back to Basics The Five “C’s” of Credit <ul><li>Capital </li></ul><ul><li>Adequacy of funds needed by the business to allow it to operate efficiently in generating cash flow and effectively within its competitive business environment. </li></ul><ul><li>Additional sources of Capital : </li></ul><ul><ul><li>Trade credit </li></ul></ul><ul><ul><li>Mezzanine Debt </li></ul></ul><ul><ul><li>Additional Equity </li></ul></ul><ul><li>How do we measure Capital ? </li></ul><ul><ul><li>Free Cash Flow </li></ul></ul><ul><ul><li>Leverage </li></ul></ul><ul><ul><li>Don’t forget projections </li></ul></ul>
    19. 19. Back to Basics The Five “C’s” of Credit <ul><li>Conditions </li></ul><ul><li>The economic and environmental influences on the firm’s financial condition and performance </li></ul><ul><li>Conditions typically beyond the borrower’s immediate and direct control. </li></ul><ul><li>Is there a reason for this business to exist? </li></ul><ul><li>How do we Measure Conditions? </li></ul><ul><ul><li>IBIS Industry Reports (www.IBISWorld.com) </li></ul></ul><ul><ul><li>Internet searches for industry association sites, industry news </li></ul></ul>
    20. 20. Back to Basics The Five “C’s” of Credit <ul><li>Collateral </li></ul><ul><li>The property pledged by a borrower to protect the interests of the lender </li></ul><ul><li>Collateral should never be considered the Primary reason to make a loan </li></ul><ul><li>If you feel you need collateral in support of the loan, make sure that you measure it, manage it and control it </li></ul><ul><li>The final source of repayment, the last protection against loan loss. </li></ul>
    21. 21. Wait… Covenants <ul><li>Return to the use of maintenance covenants </li></ul><ul><ul><ul><li>Fixed Charge Coverage </li></ul></ul></ul><ul><ul><ul><li>EBITDA </li></ul></ul></ul><ul><ul><ul><li>Minimum excess availability </li></ul></ul></ul><ul><li>Springing covenants are still common in larger credit facilities, triggering based on availability </li></ul>Source: Dev Strischek, The Five C’s of Credit, The RMA Journal, May 2009, 34 - 37 One More C
    22. 22. Some More Basics <ul><ul><li>Greater scrutiny with respect to add-on acquisitions </li></ul></ul><ul><ul><li>Need to focus on key drivers of appraisal values and not just a number in the Executive Summary </li></ul></ul><ul><ul><li>Asset values may not behave independently of cash flow in the underlying business and industry </li></ul></ul><ul><ul><li>Customer and vendor checkings can be invaluable </li></ul></ul>
    23. 23. Asset Based Lending: <ul><li>Commercial Finance Association: https://www.cfa.com </li></ul><ul><li>Risk Management Association: http://www.rmahq.org </li></ul><ul><li>American Management Association: http://www.amanet.org/ </li></ul><ul><li>American Institute of Certified Public Accountants (AICPA): http://aicpa.org </li></ul>Back To Basics
    24. 24. <ul><li>Norman Smith </li></ul><ul><li>Vice President </li></ul><ul><li>Manager-ABL Underwriting </li></ul><ul><li>Mount Laurel, NJ 08054 </li></ul><ul><li>Phone: 856-813-2660 </li></ul><ul><li>Mobile: 856-308-4110 </li></ul><ul><li>Fax: 800-352-1231 </li></ul><ul><li>[email_address] </li></ul><ul><li>My blog, the Lenders’ Café : http://normansmith.wordpress.com </li></ul>
    25. 25. <ul><li>Ira Kreft </li></ul><ul><li>Managing Director & Region Manager </li></ul><ul><li>RBS Business Capital </li></ul><ul><li>Chicago, IL </li></ul><ul><li>Phone: 312-777-3624 </li></ul><ul><li>Mobile: 312-305-6834 </li></ul><ul><li>Fax: 312-777-4001 </li></ul><ul><li>[email_address] </li></ul>
    26. 26. <ul><li>Visit CFA’s Group on www.Linkedin.com </li></ul>

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