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5 C's of Credit

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5 C's of Credit

  1. 1. Presented by: Chuck Nwokocha Senior Risk Management Consultant
  2. 2.    Financial information company that provides credit and risk management solutions to financial institutions Data and applications used by thousands of financial institutions, corporations and accounting firms across North America Awards  Named to Inc. 500 list of fastest growing privately held companies in the U.S.  Named to Deloitte’s Technology Fast 500
  3. 3. Chuck is a graduate of Harvard University, with a B.A. in Psychology with a focus in Organizations and Economics. He began his professional career with Guardsmark, a private security services company where he held various positions and responsibilities – in operations, human resources, and sales, and management. He has founded two e-commerce sites, – a social networking site for the Igbo people and – a college classifieds network. Additionally, he has consulted on marketing, social media, and usergenerated content. Chuck Nwokocha Senior Risk Management Consultant At Sageworks, Mr. Nwokocha is an expert credit & risk management consultant helping financial institutions manage their loan portfolio , focusing on the Allowance for Loan and Lease Losses (ALLL), Stress Testing, Credit Analysis, Risk Rating, , and Loan Administration management. With subjectmatter expertise, he helps financial institutions understand and comply with federal accounting guidance.
  4. 4. Enhancing Your Credit Quality 1. 3 P’s: Policies, Process, People 2. 5 C’s a. 5 C’s of Credit b. 5 C’s of Data Collection c. Credit Risk Modeling 3. Considerations for Underwriting a. b. c. Documentation for Underwriting Considerations for Underwriting Tools for Analysis a. b. c. d. e. Loan Portfolio Composition Loan Growth by Loan Type Survey Results Emerging Trends Important Ratios in C&I a. Examination concerns with C&I 4. Lending Environment 5. Examinations 6. Bankers’ Advice 4
  5. 5.  Policies  Sound underwriting  Process  An efficient, balanced approval process  People  A competent lending staff
  6. 6.  Refers to a particular way in which something is done Certified mail must be delivered to X-person. Mail/delivery requiring signatures must be signed by a VP Outgoing mail to IRS must be delivered with a confirmation receipt  Provide the framework for the bank’s lending activities  Set the standards for portfolio composition, individual credit decisions, fair lending, and compliance management  Supplemented by more detailed underwriting standards, guidelines, and procedures
  7. 7.  Refers to a way of doing something Mail gets delivered every day. When the mail is delivered, it is sorted. The sorting is determined by dept and purpose for each piece  Establishes the lending process  Assigns accountability and establishes the responsibilities of the people involved
  8. 8.  Refers to the individuals executing the process A competent lending staff
  9. 9. Tools Policy Provide the framework for the bank’s lending activities. Sets the underwriting standards for the credit decisions Process Policy establishes the lending process and the responsibilities of the people People The individuals executing the process The Tools used in the execution of the process Training Knowledge/ skills required to execute the process and use a procedure The lending staff, with the knowledge and skills, utilizing various tools, arrive at quality loan decisions.
  10. 10.  Capacity  Measures a borrower’s ability to repay a loan by comparing income against recurring debts  Can the borrower generate adequate cash to repay the loan?  Capital  Refers to the net worth, or equity, of a business  Is the borrower adequately capitalized within industry standards to withstand unexpected loss?  Conditions  The economic, industry, and market environment can and will change; the state of the borrower or the state of the economy  Is the borrower flexible enough to adapt?
  11. 11.  Collateral  Helps secure the debt.  Is there an alternative source of repayment in case the primary source fails?  Character  Personal integrity of business owners and officers  Is management willing to repay the loan and will it attempt to do so under adverse conditions?
  12. 12. Credit Risk     Determining risk factors Understanding credit quality (risk grading/risk rating) Likelihood that a business/borrower/relationship may default on its financial obligations Model should account for different types of loans as well as industries (diff industries require diff capital structures)
  13. 13. Global Cash Flow Analysis  A complete picture of the financial condition of a small business requires a careful review of income statement and balance sheet information for both the guarantor and the business. Personal assets are often pledged against the debt of the business, and business and guarantor financial assets occasionally are intertwined.
  14. 14.    It’s common for owners to lend personal funds to, or borrow funds from, their businesses. It’s common for the business (for tax advantages, primarily) to rent its office/warehouse/production facilities from a real estate holding company or partnership controlled by the business owners. It’s common for owners to control their own levels of salaries, bonuses, benefits, and dividends to the extent allowed by prudence and tax regulations.
  15. 15. Annual Reviews   Set a minimum review period that allows continual and regular monitoring and reassessing of risk The reviews will lead to early identification of deteriorating conditions Trend Analysis    Companies rarely remain in a static condition Cash flow cannot be the only determinant Credit analysis is much too complex to rely on just a single indicator
  16. 16. 700 600 500 400 Growing Business Deteriorating Business 300 200 100 0 2007 2008 2009 2010 2011 2012 A look at the trend is critical in determining if the business in growing or deteriorating.
  17. 17. Caliber  Refers to the quality of the financials provided. What types of financials? - Audits - Tax Returns - Reviews - Company prepared - Compilations Complete  Are all of the forms/ schedules present? Did the borrower provide debt schedules? Consistent  Are the financials consistent? Did the borrower provide compilations one year and tax returns another year?
  18. 18.  Current  Did the borrower provide the most recent financials?  Conversation  Conversations with the borrower(s) help to cover those gaps in information as well as provide supplemental explanation or lend additional insight
  19. 19. 1. Financial information – used to establish repayment capacity A. Business financials -Current and historical income data, balance sheet -Balance sheet, income and cash flow projections -Comparative industry data when appropriate B. Guarantor financials -Guarantor support and related financial information -Summary of borrower and affiliated credit relationships 2. Collateral identification and valuation -Collateral agreements and appraisals
  20. 20. 3. Loan structure information  Loan terms, including tenor and repayment structure  Pricing information, including relationship profitability data 4. Loan agreement  Covenants and requirements for future submission of financial data  Exceptions to policy and underwriting guidelines  Promissory notes, note guarantees 5. Supplemental Information  Information fields to capture data for concentration reporting, identifying SNCs (Shared national credits) etc.  Risk rating or recommended risk rating
  21. 21.       Understanding financial statements and the significance of the ratios requires both skill and time Translate financial numbers into meaningful assessments of company’s financial performance Tackle these complex sets of information, condense the information into digestible chunks Utilize software, such as the Sageworks Analyst solution To input the information, to spread it into a consistent and standard format, and generate an analysis of the ratios Concentrate on the key aspects of liquidity, leverage, and cash flow, using ratios, trends, and industry analysis to study them
  22. 22. Business(es) Personal Guarantor(s) Real Estate Real Estate Eliminate Double-Counting Sageworks Analyst™ Global Cash Flow 22 TruGlobal™ Credit Analysis • Standardize cash flow analysis • Improve accuracy
  23. 23. Sageworks Analyst™ TruGlobal™ Credit Analysis • Standardize cash flow analysis • Improve accuracy
  24. 24. Sageworks Analyst™ TruGlobal™ Credit Analysis • Standardize cash flow analysis • Improve accuracy
  25. 25. Sageworks Analyst™ TruGlobal™ Credit Analysis • Standardize cash flow analysis • Improve accuracy
  26. 26. Sageworks Analyst™ TruGlobal™ Credit Analysis • Standardize cash flow analysis • Improve accuracy Combines multiple businesses, people and properties to view global cash flow and debt service numbers Eliminates double-counting Accurately assesses impact to Debt Service Coverage Ratio
  27. 27.  C&I loan competition intense and increasing  C&I and loan underwriting standards easing  Net easing for 8 consecutive quarters. CRE lending standards easing, but credit supply relatively tightened in 2012  C&I loan rate spreads decreasing     60% of bankers surveyed report ↓ spreads for loans to larger businesses. 46% of bankers surveyed report ↓ spreads for loans to small businesses. Regulatory authorities increasing exam scrutiny of C&I lending practices
  28. 28. Source: Federal Reserve Board “Senior Loan Officer Opinion Survey on Bank Lending Practices,” May 2013.
  29. 29.  Longer terms with lower payments  15, 20, 25, & 30 Year Amortizations  3, 5, 10, 15 Year Fixed Rates    Fully amortizing; no balloons or calls Preference for Owner-Occupied Properties or Investor Properties Full collateral coverage not required  Preference for up to 75% Loan to Value (LTV)  Minimum 1.25 DSCR  Personal Guarantees  Full and unlimited personal guarantees from all owners of 20%+
  30. 30.  Key Drivers of cash flow Sales (Revenue Growth) Gross Margin Accounts Receivables Accounts Payables Inventory Days S, G & A (Selling, General, & Administrative Costs) – better known as overhead.  Capital Expenditure      
  31. 31.  Liquidity ratios     Current ratio Quick ratio Working capital Leverage ratios    Debt service coverage Interest coverage ratio Debt to Equity Ratio Efficiency ratios      Accounts Receivables days Accounts Payables days Inventory days Profitability ratio  Gross Profit and Gross Profit Margin
  32. 32.  Inexperience with business entities    Global cash flow analysis methodology    Financial data: what to collect, when Industry specifications: what is normal for a particular industry Move from collateral to cash flow analysis Avoid double-counting, while recognizing intermingled income and debt Inadequate strategic planning   Policies & procedures account for C&I New risk appetites
  33. 33. 1. Re-evaluate concentration limits and risk appetite 2. Review Underwriting Policies 3. Train personnel, the board 4. Invest in technologies 5. Hire appropriately 6. Look outside the institution (potentially)
  34. 34.  Asset quality is a huge area of focus by examiners  Main criticism areas included:  Risk rating systems  Higher rates of delinquent and non-performing loans  Loan reviews that weren’t completed annually or were inconsistent  Quality issues related to the financial institution’s growing pains, the overall economy or continued real estate devaluation
  35. 35.  Many comments relate to documentation of loan files, tracking information and global cash flow analyses:  “Document everything, even if you think it’s trivial.”  “Make sure all info is current.”  “Be on top of flood insurance and exceptions.”  “Document EVERYTHING.”  “Calculate twice, print once.”  “Focus on global cash flow and asset verification.”  “Policies should be written and followed.”
  36. 36.  Bankers mentioned thorough documentation as a benefit. Among some other pieces:    “Our exam did have some former OTS examiners, and there was definitely a different approach taken by them. The lead reviewer had to focus them on the areas that really needed evaluated. They were picking on things in the file that were five years or older that were irrelevant to the credit risk today.” “Need to remain patient and carefully explain Bank’s position. Prudently point out differences of opinions. Ask for clarification of criticisms.” “Dinged for little things; need more documentation; did not like missing documents in loan files; better analysis.”
  37. 37. Presenter Contact Information: Chuck Nwokocha, Sageworks (919) 851-7474 ext. 637 Next Webinar: Loan Workout 101 for Financial Institutions Thursday, September 12, 2:00 PM EDT