Credit Analysis Training for Credit Officers Banque Populaire Regional Tangiers, Morocco March/April, 2009 FSVC Volunteer – Harris Berger Financial Services Volunteer Corps March 30 – April 4, 2009 Section I Credit Culture & The Risk Management Process • • A profitable commercial lending business requires strong portfolio quality, which, in turn, requires an effective risk management process Defined as the process of managing risk-taking throughout the organization Necessary Internal Ingredients of a Risk Management Process • • • • • • • • • Strong credit culture with active senior level involvement Independent risk management oversight Approval authorities based on experience and judgment Portfolio diversification by geography & industry Management concentrations; Adherence to limits Standards for client selection and underwriting Effective credit policy and risk rating system Standards for identifying and tracking exceptions Effective process for risk reporting and data analysis Necessary External Ingredients of a Risk Management Process • • • • • • • Strong accounting and auditing standards Legal and court system to allow enforcement of loan agreements contracts and collateral Effective bankruptcy and insolvency process Reliable credit reporting agencies allowing banks to obtain borrower histories and credit scores Standards for effective exchange of credit information and customer experience among banks Conducive regulatory environment where banks are encouraged to take a risk/return approach to lending, and where regulatory focus is on each bank’s risk management process Borrowing public knowledgeable with bank products, borrowing alternatives, application procedures Section II Due Diligence & Data Expectations Information Sources – Areas of Inquiry • • • • • • Business plans, financial projections Industry, market data Historical financial statements, personal financial statements Accounts receivable and accounts payable aging, inventory breakdowns Tax returns – business and principals References – former banks, vendors customers, competitors, other bank customers • Verification of resume data, employment history and loan application data Information Sources – Areas of Inquiry (Cont ) • Background checks on key managers, directors, owners • Assessment of management and director quality • Internet and press checkings, credit bureau reports, industry and trade publications • For public companies – analysts reports, public filings, rating agency reports • Visits to key offices, warehouses, production facilities • Collateral inspections and appraisals, review of insurance • Review of key sales and supply contracts • Assessment of accounting systems, policies and practices, information systems and controls, effectiveness of internal and external audit programs Information Sources – Areas of Inquiry (Cont ) • • • • • • • • Face to face meetings with external auditors Initial and periodic field exams, direct account verifications Verification of borrower and guarantor liquidity Legal review – entity status, licenses, lien searches, litigation, prior insolvency proceedings, regulatory issues, insurance claims, environmental liabilities Review of related party transactions Internal inquiries and scans for prior business with company, owners or key managers Review of property rent roll information, leases Review of other borrowing arrangements – collateral, guarantees, terms, covenants Specific to SME’s: • Smaller SME’s may lack sophistication and resources for strong financial reporting • Bankers can provide the financial discipline necessary to make these businesses successful Additional risk rating concepts • Migration • Double jumps • Dual rating systems – Obligor Rating / Facility Rating – Probability of Default / Loss Given Default Sample risk rating system Superior Excellent Strong Above Average Acceptable Generally Acceptable (Bankable with Care) Criticized – Special Mention: Potential Weakness, Transitional Classified – Substandard: Well Defined Weakness, May be Impaired Classified – Doubtful, Impaired Loss – Uncollectable Handouts Credit Risk Rating Grid Sample Risk Rating Worksheet Section VII Monitoring and Early Warning Signs • Importance of regular customer contact • Importance of timely receipt of financial statements, annual and interim statements • Credit file maintenance, annual file comments • Monitoring of customer performance, industry conditions, credit usage, delinquencies, overdrafts, changes in management, account history, changes in credit scores Internal portfolio reviews 3 Goals Assess performance versus expectations Confirm risk ratings Set strategy for deteriorating credits Handout & Case Study “Warning signs of a Troubled Credit” Case Studies for Group Discussion (from FSVC Volunteer Rick Clarke): – Retail Leasing Maroc (LTM) – Transport Express Ltd (TEL) – Pan Africa Security, Ltd (PAS) Section VIII Asset-Based (Formula) Lending Characteristics of Asset-Based Borrowers – – – – – – High growth Seasonality High Leverage Tightening cash flow Industry downturn Acquisitions Receivables as Collateral • • • • • • • • • • • • Payment terms Delinquency trends, turnover Characteristics of account debtors Concentrations Credit and collection practices Accuracy of internal accounting and reporting Dilution (Returns, Allowances, Discounts, Bad debts, Contra Accounts) Foreign accounts Government accounts Intercompany accounts True sale versus contract receivables Cross aging Inventory as Collateral • • • • • • Content, perishability Raw materials / work in process / finished goods Costing / Accounting Methods / Valuation Physical condition, obsolescence, turnover Marketability In transit and consignment inventory Field Exams • • • • • Purpose : Valuation, Verification, Identify Credit Risks Review of accounting systems, information and reporting quality, systems and controls Cash accounts – deposit activity, review of disbursements Accounts receivable - Identify exposure for loss (bill and hold, pre-billing, partial shipments, dilution), verify of shipping, review and reconcile aging reports, credit process, concentrations Inventory – Identification of exposure for loss (theft, manipulation of components, impaired marketability, overstatement of quantities), validation of costs and quantities valuation at lower of cost or market, physical inspection Structural Components of The Asset Based Loan • • • • • • • Initial and periodic field exams Inventory and accounts receivable eligibility (3 billing cycles rule), advance rates (2x dilution+10% rule) Inventory caps Monthly accounts receivable and inventory reporting Blocked accounts, dominion over cash Daily / Weekly borrowing base reporting Concentration limits, Cross aging limits Section IX Concluding Case Study Handout & Case Study TTT Tapioca Co Ltd (Formulated by FSVC Volunteer Rick Clarke)