MANAGING CREDIT RISKS

Credit: You make bad investments or bad loans……In danger of losing principal or interest…

Necessity to take charge off or write off in a hit to your capital base…can’t do too many of these….

Need to evaluate the reason for the credit hit—Was it firm specific or systemic..

What could you have done to lower the risk?

Just make good loans or good investments!

Easy….right !!!!

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(OVERHEAD) Real Estate Lending

Whether we are considering single family, multi-family or an office building…it still comes down to cash flow.

1. Does the job the individual has pay enough to cover amortization?

2. How many apartments have you rented in the complex to generate enough cash to cover the interest and principal of the note?

3. How many floors in the office building have to be rented to cover early cash flow?

To often the assumptions the borrower is making are not realistic…

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In the case of an individual we are talking about mortgage scoring models.

Primarily looking at time on the job, pay level, other debts…..

Can we look at characteristics of past defaulters and learn something? Most likely yes….

Lending adage…”The bigger the loan the bigger the haircut”….

The apartment building or office building will get lots more scrutiny than the house…bigger loan, bigger risk, less liquid.

(OVERHEAD) GDS/TDS

Don’t forget to perfect the security interest in the collateral…the lien.

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Your hedge against being totally wrong is being able to retrieve the original asset.

(OVERHEAD) LOW DOC/NO DOC

(OVERHEAD) SMALL BUSINESS

Small business lending is all cash flow based. The expectations model—What if?

Usually poor accounting records. Cash business often. Lots of sweat equity.

(Talk about Suds and Buds)….

Normally smaller type loan with medium margins so don’t generate a lot of revenue for the bank. ($50k loan at 10% only generates $5k in interest)…

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Tough business to make money in….Normally rides solely on the owner. Assessing management is more important than the business plan.

(OVERHEAD) MIDDLE MARKET

Middle market lending ($5 to $100 mil. In sales) starts with a bigger business, with better accounting, more info about the operation. Info comes from customers, venders, competitors..

5C’s on the overhead.

Important ratios to calculate……

Fixed charge coverage

Asset management ratio –peer comparison of asset utilization efficiency.

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Current ratio

Quick ratio…

Cash flow from operations is the key. Once the loan is made conditions precedent must be met right away.

(OVERHEAD) LARGE BORROWERS

Most have many options other than the bank. Go to the public debt markets for example.

“After you borrow at a certain level you are really in charge…not the bank”.

(OVERHEAD)

Do banks really know their costs?

Not before RAROC…Risk Adjusted Return on Capital….compares similar

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borrowers to determine likelihood of default. Considers all revenue flowing from the company to the bank…..

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