Credit Management Chap 8

Prepared by John Anderson, Queensland University of Technology

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Chapter Eight

Corporate Lending

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Learning Objectives

• Apply the principles of corporate lending

• Explain the application of lending criteria

• List the contents of the loan structuring proposal

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Learning Objectives

• Discuss the importance of financial information

• Explain the importance of managing the loan portfolio

• Demonstrate awareness of available loan products

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Introduction

• Corporate lending is still more of an art than a science

• Credit scoring techniques still being developed, although a percentageof loans will still go bad

• The lifecycle of loans highlights differences between lending and corporate entities

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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

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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

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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

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– 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

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• Methods of lending assessment– Two key methods applied, namely the 5 Cs

and PARSER approaches

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– 5 Cs• Character

– The character of a corporation veryimportant

– 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?

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• 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

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• Conditions– Lender must consider internal and

external forces likely to affect the project

• Capital– Requires careful analysis of company’s

financials

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– 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

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• 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?

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• 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

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• 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

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– 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

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– 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?

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– 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?

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– 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

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– 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

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– 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

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– 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

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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

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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

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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?

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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

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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

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• 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

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• 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

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Education

Credit Management Chap 8