CREDIT RISK ANALYSIS

CASE STUDY
ORION INDUSTRIES
CASE HISTORY
Introduction
This case study is a multi-part exercise that illustrates various elements of the credit
process. Your study of the Orion case begins with issues pertaining to target marketing
and qualitative analysis. As the case develops you will be introduced to the entire
gamut of the credit process including additional data gathering activities further
qualitative analysis financial analysis credit structuring approval administration and
account management.
!n the first part of the case you will be introduced to the potential customer and the
bank the need that brings them together and important background information
regarding the country"s macroeconomic scenario and the customer"s operations.
The second part of the case also in this unit takes you on a plant visit where you will
gather additional qualitative information.
#ubsequent parts of the case covered in $nits Three %our and %ive deal with financial
&quantitative' analysis and then credit structuring approval documentation and
administration.
(ow begin Part One of the case study and then complete the exercises that follow.
Part 1
First Customer-Baner !eetin"
)eo Aries a senior account executive with the )ibra *ank located in the +egasus
region of Andromeda was catching up on paperwork. ,is secretary advised him that a
-r. #corpio from Orion !ndustries was in the office and wished to speak with him about
possible financing.
Aries was surprised because a screening process within the unit"s target market
definition first identified most potential customers and there was very little walk-in
business. Also he knew most of the companies in the region but had only vaguely
heard of Orion. (evertheless he instructed the secretary to show -r. #corpio into one
of the conference rooms.
-r. *runo #corpio the general manger of Orion and in his early forties introduced
himself. .Your friend /eorge 0irgo from the 1unning 2lub gave me your name as a
reference. 3e 4ust had lunch nearby so ! look the liberty of dropping in.5 On two
previous occasions 0irgo had recommended that people talk with Aries mostly for
i
CREDIT RISK ANALYSIS
CASE STUDY
financial advice. *oth times Aries had quickly determined over the phone that the
potential customers did not fit into the unit"s target market definition.
Aries was interested in developing business with medium to large industrial enterprises
that had good growth potential. ,e actually preferred the smaller companies within this
range firms which could grow along with the bank but were not first tier enterprises that
could demand premium pricing and a lot of favors.
Economic#Po$itica$ Bac"round
Andromeda is a medium si6ed quiet democratic country with a population of about 78
million people. ,istorically the economy had been based on agriculture but a
significant industrial infrastructure has developed in the past 9: years. This
development was part of an economic plan for employment generation and business
sector diversification. As a result of an economic slowdown in the early and mid 98;<s
the country"s economic development in recent years has been directed more towards
the export sector particularly those exports that provide a high product integration
percentage &value added content'. There is significant potential for maximi6ing the yield
of exports due to the country"s considerable deposits of basic raw materials.
The gross domestic product &/=+' of Andromeda is about $#> ?7 billion resulting from
positive but modest levels of growth during the early and mid 98;<s. -ore recently
/=+ growth rates have been in the range of @A to :A and one of the more dynamic
sectors of the economy has been manufacturing with growth in the ?A to BA range
over the past two years.
-onetary and fiscal policy in Andromeda has been fairly stable. 1elatively small deficits
in government expenditures have been financed internally but these deficits and the
recent rapid growth in several economic sectors have resulted in moderate but
persistent annual inflation in the 9:A to 9;A range.
The monetary unit of Andromeda is the )cy currently valued at )cy @<C9 $#>. =uring
the past three years the )cy has devalued at the rate of about 9<A to 97A per year
which is consistent with the inflation differential between Andromeda and the hard
currency countries with which it trades.
%i&ra Ban and t'e Pe"asus Re"ion
Andromeda has 7@ commercial banks and several speciali6ed agrarian and
development banks. The commercial banks are permitted nationwide banking although
only the top six banks maintain a truly national presence. A second tier of eight regional
banks maintains an influential position in important but geographically limited regions of
the country.
)ibra *ank is one of these regional banks located in the +egasus region about D<< km
from the capital. +egasus has traditionally been an agricultural region but in recent
years has sustained considerable growth in the industrial sector. This region is home to
a ma4or automobile manufacturing and assembly operation established eight years ago
by a well-known multinational auto producer. This car plant has spawned numerous
ii
CREDIT RISK ANALYSIS
CASE STUDY
parts manufacturers that supply the assembly plant many of which are partially owned
or affiliated with foreign car parts makers.
)ibra *ank is a full service bank with about )cy 9< billion in assets. !t has contributed to
the industrial growth of the region by financing several ma4or manufacturing pro4ects
and by offering extensive short term financing facilities and other traditional banking
services. The industrial sector represents about @<A of the )ibra loan portfolio as a
result of marketing efforts in the last several years to capture ma4or segments of this
sector around +egasus.
Orion Industries and !r( Bruno Scor)io
.-r. Aries thank you for seeing me on such short notice. +lease let me tell you about
Orion !ndustries. 3e are medium si6ed metal works with annual sales of about )cy 7:<
million. 3e have been in business for 7@ years in +erseus &bout ?< km away'
manufacturing different types of high precision metal products. =uring the past few
years we have produced a variety of products. Our main product has been axle and
transmission assemblies for tractors working as a subcontractor to Andromeda Tractor
3orks. -ore recently we have been producing universal assemblies and rear axles for
the +egasus Automobile +lant. This is 4ust the beginning of our involvement with the
car sector which we believe has a very high potential within the country.5
#corpio explained the company"s history. Two brothers who immigrated to Andromeda
thirty years ago started Orion. The Taurus brothers excellent craftsmen and honest
entrepreneurs successfully managed the firm for many years. Eventually the scope of
operations became more than a large family business could handle and profits started
to slip. Even though they took on extra business training more people and purchasing
more equipment profits stayed at the same level as when they were half the si6e.
Three years ago the Taurus brothers were introduced to #corpio. ,e had a degree in
mechanical engineering from a good university &the $niversity of Andromeda' and had
spent many years working with a large Andromeda company in the metal products
sector. Over the years he had built up expertise in administration especially in the area
of cost control for manufacturing operations. ,e saw a good opportunity at Orion
because of the high-quality products and the business potential in the nearby +egasus
region. #corpio invested some of the personal savings in Orion and became the general
manager and one-third shareholder with an option to purchase a ma4ority position.
The two brothers now in their late fifties are still active in the company on the
production side. #corpio has streamlined operations by eliminating some marginal
products with small profit margins and emphasi6ing the tractor subcontracting work and
the diversification into the auto sector. Orion has been delivering for three months
under its contract with the +egasus Automobile +lant achieving good quality and a
strong on-time production record.
iii
CREDIT RISK ANALYSIS
CASE STUDY
Financin" Re*uest
.The reason for my visit -r. Aries is that we are looking for new banking relationship.
2urrently we are working mostly with the local branch of the /emini *ank and they
provide adequate services for payrolls and a limited amount of lending. ,owever they
do not have the expertise or resources to deal with our pro4ected future needs. 3e are
looking for a long-term relationship with a large regional full service bank such as yours.
Our mutual friend /eorge 0irgo mentioned your name and your bank so here ! am.
.3e would like to establish a short-term facility for )cy @< million &equivalent to $#>
9<<<<<<'. 3e would want periodic drawdowns for working capital purposes mostly to
help us finance receivables or to stock up on raw materials for particular 4obs. Although
! have made every effort to even out the workflow at the plant some degree of
seasonality is unavoidable. The credit line will help us here.
.3e anticipate future capital needs for upgrading or relocating the plant but that"s still a
long way off. 3e would however like to establish financial relationships now so that
when these futures needs arrive we can count on the necessary financing. 3e have a
couple of other prospective banks but have come here first because of your bank"s
reputation for thoroughness and imaginative financing.5
In+itation to ,isit
.3e would like to invite you for a visit to our factory at your earliest convenience so that
you can meet our people and 4udge Orion !ndustries for yourself. Our external auditor
the well-known firm of 2apricorn F 2entauri will have our annual report finished in
about two weeks and ! will instruct them to send it to you as soon as it is ready. ! would
prefer to have you visit us before then so we can get the ball rolling as soon as possible.
3e anticipate some short term financing needs in about six to eight weeks and if your
bank is not interested we would have to pursue other avenues.5
Aries and #corpio said good-bye. .An interesting meeting5 thought Aries .he seems to
know what he"s talking about.5 Aries liked #corpio for his easy open and unpretentious
manner.
Aries wasn"t sure what to make of this customer falling into his lap but thought that
pursing the opportunity would be worthwhile. All he had to lose at this point was a little
time and in any event it would be interesting to visit the customer"s factory. That way
he could identify the qualitative parameters of a potential banking arrangement to
decide whether or not to continue with a complete risk analysis.
The banker had to organi6e the information he gained from the initial interview with the
potential client and decides what information he should get during his visit to the plant.
iv
CREDIT RISK ANALYSIS
CASE STUDY
ORION INDUSTRIES - Part .
Introduction
!n +art One of the Orion case we were introduced to the banker the potential customer
and the economic setting of the case. 3e saw that although the bank did not have a
precise definition of its target market the potential customer apparently fit within the
broad parameters established by the bank and within the country"s macroeconomic
situation.
Aries was intrigued enough to see a prospective deal and schedule a plant visit.
Through the questions in the +rogress 2heck you saw how he should organi6e his data
and plan what he would accomplish during his upcoming plant visit.
!n +art Two of the Orion case Aries displays resourcefulness in obtaining some
valuable references. ,e then proceeds with the plant visit where he gathers a great
deal of qualitative information. ,e tries to organi6e the information using the bank"s
standard qualitative data forms.
Apparently satisfied that Orion !ndustries still represents potential business for the bank
Aries starts to think about the next two steps in the credit process. These include &9'
the financial analysis of the Orion statements when they arrive and &7' the formal credit
and risk analysis to structure a deal and frame a potential credit recommendation.
C'ecin"s
*efore driving out to the Orion factory Aries decided to call Aurora *orealis a banker at
/emini *ank whom he had met in a credit course they both attended last year. Aurora
confirmed that her bank had been dealing with Orion for many years and the
relationship was generally positive. #ome credits had been renegotiated over the years
but this was normal for a company like Orion that was continually taking on different
4obs.
Aurora mentioned that /emini *ank wished to maintain its relationship with Orion by
continuing to offer current account and payroll services G and by maintaining its
exposure levels at about the present level. *ut due to /emini"s small si6e it was
already near the legal lending limit and could not meet all of Orion"s lending need.
Another bank would have to finance Orion"s proposed growth.
Aries also contacted )ibra *ank"s own account officer for the Andromeda Tractor 3orks
&AT3' and asked him to track down information on Orion"s reputation for quality and
timely delivery of the axle and transmission assemblies. After a couple of phone calls
the AT3 account officer advised that the tractor producer was happy with the Orion
relationship. The quality of work was excellent and reliability of delivery had improved
considerably over the past year. Apparently Orion had experienced some difficulties in
the past that resulted in late deliveries but this problem had now been solved.
)ibra *ank did not have a banking relationship with the +egasus Auto +lant since the
auto producer dealt only with four top-tier Andromeda banks. (evertheless Aries
wanted to get some feedback from the auto producer as to Orion"s product quality and
v
CREDIT RISK ANALYSIS
CASE STUDY
reliability. Aries assumed that the reference would be a good one but he wanted to
make sure. ,e decided to leave this matter for later.
,isit to t'e Orion Factor/
+lant and Equipment
A few days later )eo Aries drove to +erseus to visit the Orion plant. ,e found that the
concrete block plant building was old but in fairly good condition owned by the
company and free of liens. !t was located in an old area that had good access to the
highway connecting it to the heart of the +egasus region. ,owever the location was
slightly off the beaten track and far from the newer industrial areas that had developed
near the +egasus Automobile +lant. Electricity and water supplies in the area were
adequate.
!nside the plant was clean and well lighted but quite crowded with numerous large
machines. The machines though not new appeared to be well maintained and were
logically positioned to handle the workflows. They were all imported and looked
expensive. Aries was informed that some of the machines collaterali6ed existing long-
term debt with the /emini *ank and other long-term sources but outstandings were low
compared to the replacement market value of the machines. The machines were
insured at their present market value which was net of depreciation.
There were several warehouse areas within the building for storing raw materials but
these areas were randomly placed due to the cramped conditions inside the plant where
every inch of space was utili6ed. 2ontrols over inventories appeared to be adequate
with locked wire mesh compartments.
The administrative area was quite austere with old furniture wooden floors and old
photographs on the wall. There was no formality hereH the administrative staff was
friendly and comfortably dressed &no ties' and odors from the kitchen could be detected
throughout the offices. Aries was informed that the company subsidi6ed the workers"
lunches with the workers paying only a normal price.
#
Almost all of Orion"s raw materials were sourced domestically from the few Andromedan steel mills and
foundries &Andromeda #teel 3orks Andromeda -ining and -etals' and the quality of these products
was good. +urchase terms for Orion were the standard D< to ?< days. A few speciali6ed products such
as drill bits and other tools were imported due to the inferior quality of local products. These purchases
were relatively minor and were made on a cash basis using foreign exchange bought on the free market.
1egarding inventory levels #corpio figured he would have to maintain present levels of between three
and four months. .! wish our production schedule was more consistent from month to month but we must
adapt to our buyers and unfortunately this means some fluctuation in production volumes. 3e have to
keep greater stocks of raw material on hand to enable production flexibility. Over the next year however
we hope to reduce our average inventory to between two and three months.
.!"m sure you will have more questions on the financial side once you get our figures5
continued #corpio. .You"ll see that financially speaking we have improved the quality
of our income stream by eliminating some unprofitable operations and focusing on our
vi
CREDIT RISK ANALYSIS
CASE STUDY
more lucrative product lines. You should have the numbers next week so you can see
for yourself.5
Aries returned to the bank to consider what he had learned about Orion !ndustries. .An
interesting opportunity5 he thought. #o far he had a positive feeling for the potential
relationship and for #corpio. Aries admired entrepreneurs who were willing to invest
their own capital in an enterprise. Apparently #corpio had been successful at turning a
relatively unsophisticated operation into a more modern and efficient company with
prospects for considerable growth. .On the other perhaps #corpio was being too
ambitious5 mused Aries. .*ut he has demonstrated drive and determination which let"s
face it most people never attain.5
Ca$$ Re)ort
Aries was anxious to get the financial statements to complement his analysis so far and
provide a more comprehensive perspective of the situation. ,e figured that the
numbers once available would reflect an improving picture over the last couple of
years. !n the meantime and while the visit was fresh in his mind Aries decided to
complete the call report and finish the *!1 for Orion !ndustries. ,e also requested
credit references from the suppliers.
CA%% P%AN AND REPORT
2)!E(TI Orion !ndustries !nc. =ATEI 9?

%ebruary 98J@
*1A(2,I )ibra *ank +egasus 2ity +1O=$2TI 2redit +rospect
2A))!(/ O%%!2E1I )eo Aries 2A))!(/ O(I *runo #corpio 2EO
+$1+O#EI
- +lant visit for possible credit relationship
- -eeting of key management people
- 1eview of management systems and managerial focus
1E#$)T#I
- +lant is old but in good order
- -et other owners and executives
- ,ad fruitful discussion as to production market position future
- !n general had favorable impression of management
- Apparent improvement in systems and infrastructure since arrival of #corpio but some
shortcomings with lack of depth
- /rooming of additional management people is high priority
-ATTE1# %O1 %O))O3-$+I TA1/ET =ATE
- 1equest references from suppliers =one
- 1eceive audited financial statements 77 %ebruary
- Analy6e audited financial statements *y month end
- 1eceive formal bank checkings *y month end
- Obtain references from +egasus Auto +lant *y month end
vii
CREDIT RISK ANALYSIS
CASE STUDY
%eo Aries
1elationship -anager #upervisor

BASIC INFOR!ATION REPORT +age 9
*1A(2,I )ibra *ank -ain *ranch =ATEI 7C9?CJ@ #!(2EI (CA
2)!E(TI Orion !ndustries !nc *$#!(E##I -etal +roducts
A==1E##I +erseus O*TA!(E=I 1eference
O0NERSHIP
2losely held corporationI 7CD Taurus brothers 9CD *runo #corpio latter with option for :9A control.
Employee stock ownership plan to be effected for 7<A out of Taurus brothers" holdings. These
independent ownerCmanagers are apparently highly committed to the success of the firm.
DIRECTORS AND !ANA1E!ENT
/eneral -anager *runo #corpio early @<"s mechanical engineer from $niversity of
Andromeda. Experienced in prior positions with subsidiaries of ma4or multi-
nationals. #trong background in manufacturing and costCmanagement
systems.
+roduction -ax and (ick Taurus late :<"s immigrant founders self-made men.
Excellent craftsmen but not sophisticated managers.
-anagers have good reputation for reliability and integrity based on
feedback from suppliers etc.
HISTORY
2ompany was formed by Taurus brothers 7@ years ago to produce high precision metal parts. ,ave
had ongoing and positive relationship with Andromeda Tractor 3orks G and more recently initiated
higher precision production for +egasus Auto +lant. +roduct quality has been good but spotty recent
history in dependability and profits. Arrival of #corpio three years ago has helped remedy this in
productivity turnaround.
BAN2IN1 AND OTHER FINANCIA% RE%ATIONS
+rincipal bank is /emini. +roducts include short-term lending occasional equipment loans and
payroll and current account products. 1elationship has been unsophisticated due to lack of
management financial know-how. 2heckings indicate good experience with occasional past rollovers.
OPERATIONS +age 7
+1O=$2T#
- ,igh precision metal works with variety of products capability
- +rimarily tractor axle and transmissions
- (ow producing higher precision automobile universal and rear
axle assemblies
- #ome seasonality
- +erceived high quality workmanship
Sales breakdowns: Tractors 55% - Automobile 45%
%A2!)!T!E#
- Own plant located in +erseus ?< km away
viii
CREDIT RISK ANALYSIS
CASE STUDY
- Out of the way location but good access
- Own concrete block building free of mortgage
- Adequate energy and water infrastructure
- !mported machinery -- used but in good shape
- %ull insurance for depreciated market value
- 3arehouse controls adequate but crowded
- Employees appeared to be well trained
Employee relations positive, with ood productivity
#$++)!E1#
A(= T1A=E
1E+$TAT!O(
- Andromeda #teel 3orks and Andromeda -ining and -etals
for local supplies of base metals
- Kuality of local supply is good
- Terms between D< and ?< days
- #ome purchases of foreign materials paid on cash basis from
free market foreign exchange
!heckins have been "avorable
=!#T1!*$T!O(
A(= #E))!(/
TE1-#
- =irect sales to Andromeda Tractor 3orks and more recently to
+egasus Automobile +lant
- All sales on credit terms mostly 8< days
- Other miscellaneous sales when have spare capacity with
varying terms
/ood references from AT3 as to quality and delivery timeliness
AFFI%IATED CO!PANIES AND RE%ATED BUSINESS
No a33i$iated &usiness
ADDENDU! TO BIR4 !ANA1E!ENT +age D
/OA)# O1!E(TAT!O(
A(= 2O--!T-E(T
- /oals to produce more for the automobile sector
- +erception of ownerCmanagement commitment with .hands
on5 involved approach
- -anagement committed to quality serious
- 3orker productivity apparent with upcoming employee stock
ownership plan.
- %irm now has more focused orientation since arrival of
#corpio
O1/A(!LAT!O(A)
2,A1A2TE1!#T!2#
A(= =E+T,
- %irm dependent on #corpio for managerial direction and know
how
- Taurus brothers excellent craftsmen only
- +resent lack of depth
- (ew systems for delegation to permit attempt at developing
new people
- +resent centrali6ed authority OM for level of operations but not
for growth into new products
*A2M/1O$(=
A(= )E0E) O%
MEY -A(A/E1#
- #corpio has strong manufacturing background with particular
strength in cost accounting and management systems to track
result
- #corpio experience gained with Andromeda subs of ma4or
multinationals
- Taurus brothers have strong background as craftsmen with
credibility for quality
- *rothers weak on administrative side
i#
CREDIT RISK ANALYSIS
CASE STUDY
3O1M ,A*!T#
A(= -A1MET
1E+$TAT!O(
- 2ommitment to quality and excellence
- 1eputation for thoroughness and on time delivery although
some slippage here before
- 3ork force apparently well trained
- 3ork force motivated with productivity pay
- Employee turnover apparently healthy lower than normal
- %irm has good reputation for integrity
-A(A/E-E(T
#Y#TE-# A(=
2O(T1O)#
- (ew systems fill vacuum of prior management
- 2ost accounting systems have brought back profitability vs.
prior marginal results
- -anagement information systems track productivity and work
defects by product line
- *udgeting systems permit controlCdelegation
A22E## TO
TE2,(O)O/Y
- +roduct is craft but not .high tech5
- -achinery appears adequate for needs
- -achinery apparently maintained by own staff under
supervision of Taurus brothers
- Technology at hand appears to be adequate
#
Case Study
ORION INDUSTRIES
Introduction
3e now return to the Orion !ndustries case which was introduced in $nit One.
!n +art One we were given some background on the economic and political
situation in the Third 3orld country of Andromeda and the +egasus region of the
country. 3e were introduced to Orion !ndustries and *runo #corpio and
witnessed the origination of a potential credit relationship with )eo Aries of )ibra
*ank.
!n +art Two of the case the banker obtained some additional information from
third parties and visited the Orion plant. At the plant he met the rest of the Orion
team and gathered a considerable amount of qualitative data about the company
how it operated and its people. The banker then organi6ed this information in
anticipation of receiving the financial statements.
!n +art Three of the case history the financial numbers are put into a
spreadsheet format. The banker must analy6e the financial statements of the
Orion 2ompany toI
determine the financial soundness of the firm and
measure historical cash generation capacity.
The analysis allows him to draw some conclusions about the relative risk and
creditworthiness of Orion as a potential borrower. !t also raises some additional
questions about what can be reasonably anticipated in the future.
COMPARATIVE STATEMENTS OF FINANCIAL CONDITION ENCLOSED
$$
Case Study
ORION INDUSTRIES Looking to the Future
At Orion #corpio has come in to .clean house5 financially and has
reduced both the scope of operations and the si6e of the balance sheet.
The banker must ask how far this .downsi6ing5 will go and what will
happen in the future.
The financial statements will probably level off soon and perhaps start to
grow again which could mean additional external financing needs for the
firm. This is the reason #corpio came to the bank in the first place. !t is
likely that some of the historical figures &such as reduction of current
assets' are not indicative of near term future operations of the firm. *ut
other figures such as profitability and efficiency ratios probably are
indicative of future results under the present management.
The anticipated future financial growth is now a more pressing concern for
the banker. The statements that are being analy6ed while indispensable
for the financial and overall credit analysis of the firm are history G yet any
extension of credit will be for the future.
The banker must therefore have an idea of the likely near-term financial
development of the firm. ,e has to calculate the situation under a growth
profile with a heavier debt load anticipating takedowns under an assumed
new line of credit with )ibra *ank. To do this the banker should prepare
some pro4ections to compare with the company"s forecasts.
This can be done informally pro4ecting out key balance sheet accounts for
one year to measure increased funding needs and the effect on the
balance sheet ratios. The banker should therefore obtain from #corpio
sufficient information to build these informal pro4ections. #pecifically he
needs to knowI
anticipated sales growthH
cgsCsales and other key marginsH
reasonable assumptions for G
- days receivable
- days inventory
- days payable and
- other current assets and other current liabilitiesH
anticipated capital expenditure levelsH
payment terms for existing long-term debtH
dividend policiesH and
any anticipated other new external funding.
$%
Case Study
)et"s continue to +art %our of the case and find out how Aries gets the needed
information and performs the pro4ection exercise.
+A1T-@
%ollow-up =iscussion with #corpio 1egarding ,istorical %igures
The banker called *runo #corpio to schedule a meeting. The purpose of the
meeting was to discuss some questions about the Orion financial statements
future goals and assumptions for this year"s financial operations. Aries asked
#corpio to provide a copy of the receivables aging report.
At the meeting Aries quickly reviewed the aging report with #corpio and
concluded that the information did not indicate any problems with stale
receivables. .3e did experience some problems in 98J9 and had to write off
some uncollectibles for two small 4obs we did5 said #corpio. .This write-off
affected earnings in that year which you can see on our financial statements.
.!t was this type of experience that drove us away from many of the smaller 4obs5
continued #corpio in response to the banker"s questions. .The margins may be
better but they involve a lot of headaches with retoolin, cost accountin "or speci"ic &obs,
and workin with some di""icult customers' That is why we are presently dealin only with the Andromeda
Tractor (orks )AT(* and the +easus Auto +lant )+A+*' Even thouh we have no collectibility problems,
the market strenth o" these two companies "orces us to rant loner credit terms than we would pre"er'
(e,re workin on this and hope to neotiate somethin better this year, but we,re not countin on it'
.3e reali6e that limiting ourselves to two basic clients for now perhaps does not
diversify us as much as we would like. ,owever these are the types of
relationships we hope to build for the future. Although the net income per unit
sold is not great the volume of work is attractive and we can gradually improve
profits by reducing unit costs. The work provides stability over the longer term
which is also quite attractive to us. 3e hope to enter into even longer term
contracts when the present twelve-month deals we have signed over the past
two years with +A+ expire.5
!n response to questions about the reduction in days payable #corpio indicated
that in earlier years the firm bought from a greater number of suppliers. #ome of
them offered longer terms probably because the quality of their product was
inferior. .!n fact5 said #corpio .this was one of our problems. The mixed quality
of raw materials affected our own product quality. 3e are now purchasing from
three prime suppliers that have the best quality materials but they are more
demanding in terms of timely payment. Our days payable have been reduced
from prior years because we are not a big enough customer for them to grant
concessions on trade terms. Although we had hoped to limit our need for other
working capital financing by relying on trade credit we have been unable to do
so.5
$-
Case Study
!nformation on Other 2redit 1elationships
Aries also inquired about some of the other creditors that appeared in the notes
appended to the audited statements specifically about #agittarius *ank and the
Andromeda =evelopment *ank. #corpio informed Aries that the relationship with
#agittarius *ank was being liquidated by paying down the long-term equipment
loan as it came due. This was also part of the reason why #corpio had
approached )ibra in the first place.
The reason for terminating the relationship was because #agittarius *ank had
recently experienced financial difficulties. .Our relationship with them has been
cordial and proper5 said #corpio .but we don"t feel we can count on them in the
future for new short-term takedowns.5 Aries accepted this explanation since he
knew about the situation with #agittarius. !n fact several other #agittarius clients
had recently requested significant credit increases at )ibra. (evertheless
#corpio made a mental note to request checkings from #agittarius.
#everal years ago the Taurus brothers had approached the Aquarius %inancial
2ompany during a cash crunch and some loans had been hastily arranged with
cash collateral provided by the Taurus brothers. Although the finance company
was owned by acquaintances of the brothers it charged high spreads for these
loans since it normally did not provide financing to the industrial sector. *ecause
of their inconvenient terms these loans were also among the first to be put on a
liquidation basis after the arrival of #corpio.
The credit with the Andromeda =evelopment *ank &A=*' had been arranged by
/emini under a line of credit available to local banks to finance the purchase of
some /erman equipment under a /erman export promotion program. .+art of
the loan was financed in local currency and part in /erman -arks5 said #corpio.
.3hen ! came to the company one of the first uses we made of current asset
reductions was to eliminate the cross-currency exposure by prepaying the
/erman -ark portion of the loans. The local currency portion is being paid down
as due with about three years left on the loan.5 This explanation confirmed what
Aries had figured when he saw the A=* listed as a creditor in the notes attached
to the audited financial statements.
=iscussion +ertaining to /oals and %uture +lans
!n response to the banker"s questions about return on equity &1OE' and goals in
this area the customer respondedI .The receivables writeoffs ! mentioned earlier
caused the overall 1OE for the year 98J9 to be about 7A. You can see from our
statements that our 1OE has improved considerably during the past two years.5
.!n the past two years we have spent some money installing some new machines
and our new accounting and management information systems. These
expenses have reduced our profits from what they could have been but with
these systems in place we figure that our net margin can now be improved by
about 7A which translates to an 1OE of about 77A.5
$4
Case Study
.3e ultimately would like to improve beyond this to achieve an 1OE of about
7:A which would be about 9<A above inflation. 3e are being selective with
any potential new contract requiring that it contribute to achieving this goal within
our own pro4ections.
3e are re4ecting those contracts that could become a drag on earnings. ,aving
put our house in order we must avoid tying up our resources in marginal or
underproductive deals as we have done in the past. 3e believe that our current
product quality puts us in an advantageous position and the time for pricing
concessions is past.5
#pecific #hort-term /oals
Aries then asked questions about pro4ected numbers. .(ow that we have
information on Orion"s operations and financial numbers for the past three years
we would like to have some figures on financial goals for the rest of this year.
3hat are you budgeting for sales net income current account levels capital
expenditures dividends etc.N5
.%or this year we anticipate renewed growth but only in our current product line.
3e have cut the scope of operations over the past two years about as far as we
want to go which has restored strength to our balance sheet5 said #corpio.
.3ith the contracts we already have we are budgeting annual sales of )cy 78<
million which would be about a 98A sales increase. This figure is quite firm and
it will go up if we can negotiate a production increase in our contract with the
+egasus Auto +lant.5
#corpio continued. .3e have been discussing this with +egasus for a couple of
weeks. !f we agree on terms soon beginning around -ay or Oune our production
could build incrementally up to about a 7:A increase in volume by =ecember.
This would mean an average sales increase of about D:A for the year instead of
the 98A we are pro4ecting now. Even if we don"t get the increase with +A+ we
should be able to take on another 4ob perhaps as a subcontractor. This should
enable us to reach an overall 7:A sales growth even under the most
conservative circumstances.
.!n terms of net income we"re shooting for a return on sales &1O#' of ;A based
on a decrease to B9A in the 2/#C#ales margin and to 99.:A in selling general
and administrative expensesCsales. This will be achieved through cost cutting
and increased efficiency. Although we expect some increases in short-term
borrowings the reduction of our term debt will keep interest expense at about the
same level as last year. 3e also anticipate lowering our effective tax rate to
D<A due to certain tax credits from recent investments in fixed assets. %or these
reasons we believe our ;A 1O# goal is quite achievable.
.On the balance sheet we anticipate about the same relative levels in current
assets days receivable and days payable. 3e may increase inventory slightly if
we take on the additional work with the +A+.
$5
Case Study
.As to non-operating cash needs5 continued #corpio .we"ll be paying a level of
about : million in dividends since this is the main source of the shareholder funds
for making payments under the stock purchase plans. 3e"ll also need about :
million more for capital expenditures to replace some aging fixed assets.
*ecause of these equipment acquisitions and those of recent years we expect
annual depreciation to climb to about B million.5
)onger-term /oals
The banker asked #corpio about long-term goals. ,e replied that over the long
term he hoped to position Orion as one of the larger and more significant
component producers in the country. .3e see a strong future for the automobile
sector in Andromeda not only for the domestic market but for exports as well
and we anticipate being an important part of this development. This would mean
building a new plant in the not-too-distant future since our present facilities while
adequate now and for the next couple of years are not enough to become large
producers within our market.5
.The export market is especially interesting to us. !n order for ma4or multinational
car producers such as those in the $#A to maintain the viability of their
domestically produced cars they will have to maintain or lower costs by
outsourcing many of the parts. This is where we come in. 3e feel our quality is
now approaching theirs but our prices in dollars are cheaper.5
.3e see global markets as the future for industry in Andromeda. This is what
successful Asian countries have done and ! don"t see why we can"t do the same
in Andromeda G produce a high quality medium tech product for global
companies.5
.The difficulty is getting our foot in the door. Our relationship with the +egasus
Auto +lant is extremely valuable because the ma4or $.#. multinational owner of
+A+ has its own needs in the $#A. Over the long term we hope to build a
relationship with this multinational that will permit us to grow outside of
Andromeda and insulate our business from the domestic economic situation. 3e
reali6e however that this is a long way off and we don"t expect to get there
tomorrow.5
The meeting ended and #corpio left the banker"s office. Aries thought about the
conversation. .#corpio has a great deal of drive and ambition5 he thought.
.,e"s an impressive guy seems to know what he"s talking about and has the
company financial numbers to give him credibility. ! think we can work with him
but 4ust the same we had better keep a close watch on Orion to make sure they
don"t get too far ahead of us or themselves.5
*efore turning to other matters Aries asked the administrative assistant to
request routine bank checkings on Orion from the #agittarius *ank and from the
Andromeda =evelopment *ank. .A few more numbers and we should be about
ready to put a credit proposal package together5 thought Aries.
$.
Case Study
%inancial +ro4ections
Aries immediately looked at the numbers he had written down in the meeting.
3ith these he would put together some quick informal one-year pro4ections to
see what the situation would look like as of 97CD9CJ@ under #corpio"s
assumptions. To be conservative he also wanted to pro4ect out some more
pessimistic figures to gauge the sensitivity of the numbers.
Aries then listed the assumptions both from the customer"s perspective and from
the bank"s sensitivity scenario. The important numbers were sourced from his
conversation with #corpio. ,e estimated other figures such as level of cash
other current assets and prepaid expenses from trends in the balance sheet
andCor anticipated general growth. These accounts were quite small and
therefore had less of an impact on cash determination.
The assumptions wereI
2ustomer #ensitivity
#ales /rowth D: A 7< A
2/#C#ales B9.< A BD.< A
#/AC#ales 99.: A 9D.< A
!nterest 97<<< 9?<<<
!ncome Tax 1ate D< A D: A
(et !ncomeC#ales ; A N
2ash F -arketable #ecurities )evel @<<< D<<<
=ays 1eceivable ;< 9<<
=ays !nventory 99< 9@<
Other 2urrent Assets )evel (o 2hange :<<<
+repaid Expenses )evel (o 2hange D<<<
=ays +ayable @< D<
Accruals )evel 9D<<< 99<<<
Taxes +ayable )evel :<<< @<<<
2apital Expenditures :<<< B<<<
Other (on-current Asset !ncrease P9<<< P9<<<
1eduction of )ong-term =ebt :7:: :7::
Other )ong-term )iabilities )evel 9?<<< 9:<<<
=ividends :<<< <
The banker now had to put together some quick pro4ections using the customer"s
more ambitious assumptions on one hand and more conservative numbers for a
sensitivity analysis on the other.
$/
Case Study
Financia$ Pro5ections are enc$osed
LOOKIN A!EAD
"h#t I$ Orion%$ Fin#nci#& Out&ook'
The statements "or the past three years ive Scorpio a reat deal o" credibility' 0e has been able to manae
key variables skill"ully and e""ectively and, "rom the indications we have in the case, there is no reason to
doubt that he can continue to do so 1 at least at the present or similar level o" operations'
2rom the pro&ections we can appreciate that, i" the marins and indices continue at or near present levels,
the company will probably do very well "inancially' (e can also anticipate that i" the potential rowth is
achieved, additional limited short-term "undin needs will arise' Accordin to the customer pro&ections, the
increase in short-term bank debt levels under this scenario is pro&ected at only three million pesos'
0owever, i" some o" the numbers "all short, either in pro"itability or in larer than proportional increases in
receivables or inventory, additional bank debt will be necessary, and in potentially considerable amounts'
Also, capital e#penditures could easily climb above pro&ected levels i" e3uipment in the old plant "ails and
has to be replaced, or i" new e3uipment must be purchased beyond the levels anticipated'
4ecause o" 5rion,s present stron capitali6ation, the "irm has a reat deal o" creditworthiness to bank on'
They should easily be able to obtain "unds "rom a bank, be it 7ibra or another' 8n the pessimistic sensitivity
scenario, the leverae ratio increases to only $'%5, which is well below historical levels'
"h#t I$ the Ne(t Ste) *or Leo Arie$'
The banker has been atherin a reat deal o" credit in"ormation about 5rion 8ndustries, both 3ualitative
and 3uantitative' 0e has also been analy6in this in"ormation in order to draw conclusions about the merits
o" a credit with 5rion 1 the desirability o" initiatin a bankin relationship with the company and what the
terms o" the relationship should be'
9p to this point, Aries has been actin essentially under his own initiative' Since he cannot act alone to
approve a credit "acility "or 5rion, now is the time to decide i" he wishes to promote the potential credit
within the bank and, i" so, to put toether a credit proposal packae' This will involve structurin a deal
and compilin a credit recommendation "or the consideration o" the credit committee' (e will see how this
is done in the units that "ollow'
ORION INDUSTRIES
Introduction
8n +art 2ive o" the 5rion !ase Study, the banker must decide whether to proceed with a "ormal credit
recommendation "or 5rion' 0e obtains additional "inancial in"ormation to construct a cash in"low:out"low
budet in order to structure a potential deal'
Orion C#$h In*&o+ , Out*&o+
A "ew days a"ter puttin toether the 5rion customer and sensitivity pro&ections "or $;<4, Aries "elt he
needed one last piece o" "inancial in"ormation to prepare a cash in"low:out"low budet "or 5rion' Aries
knew that the pro&ections he had made, althouh e#tremely use"ul, provided a pro&ection o" averae "iures'
4ut this did not account "or the seasonality o" the business, which Scorpio had mentioned on couple o"
occasions' The cash "low budet would help de"ine the structurin "or the potential new "acility' 8t would
provide a more detailed picture o" the cash "lows durin the year in addition to the situation at the end o"
the year'
4esides, Aries was a computer bu"" and could utili6e the cash in"low:out"low model that he had &ust
"inished devisin on his personal computer' The model was similar to that used by other banks, with a
couple o" "eatures that Aries had added' (ith the model, it would take no more than a "ew minutes to
compile the data and print it out'
$=
Case Study
0e spoke over the phone with Scorpio' The customer said, >8t,s ood that you called' 8t looks like we,ll be
ettin the contract "or increased production that we have been neotiatin with +A+' (e have ad&usted our
monthly sales budet, with production increasin sini"icantly beinnin in ?une and total annual sales now
pro&ected at 7cy -4= million' 4y September we e#pect to be producin about 5@% more than we are now
producin'A
Scorpio assured the banker that 5rion could handle the volume' >Bemember, we were producin at &ust
below these volumes a couple o" years ao, but at unpro"itable levels' Cow we e#pect to make some
money' Since we,ll be producin the same products, all we have to do is hire a "ew more people and
schedule about %5% more overtime than at present' 4ut to be conservative, we should budet a little more
"or capital e#penditures' (e,ll also have to ac3uire a couple o" new machines and keep the old ones as
backups to make sure we don,t have any e3uipment problems' E#cept "or the sales "iures 8 mentioned, the
other assumptions would be about the same as we discussed a "ew days ao'A
Inter)reting the Re$u&t$
A"ter Aries completed the cash in"low:out"low numbers, he made notes o" some observations' These will
be included in his overall "inancial analysis o" 5rion as part o" his credit recommendation, should he decide
to o ahead with the 5rion deal' The numbers also will be valuable in structurin the credit and
anticipatin when drawdowns would most like be re3uested'
CAS! INFLO" , OUTFLO" -UDET
Came: ORION INDUSTRIES 7ocation: Andro.ed# Auditor: C#)ricorn / Cent#uri 4ein ST
Debt: $5,@.@
!urrency: Lc0 Assumptions: Mini.u. C#$h1 2333 8nterest Bate %: 42 Amount o" 7ine:
56333
Amounts: Thousands
+eriod: ?an
<4
2eb Ear Apr Eay ?un ?ul Au Sep 5ct Cov Dec
Startin !ash -%54 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@
Cet Sales %@@@@ %%@@@ %4@@@ %4@@@ %4@@@ -@@@@ -%@@@ -4@@@ -.@@@ -.@@@ -.@@@ -@@@
)Accounts Beceivables
5pened*
%@@@@ %%@@@ %4@@@ %4@@@ %4@@@ -@@@@ -%@@@ -4@@@ -.@@@ -.@@@ -.@@@ -@@@
Accounts Beceivables
!ollected
%/@5. %/@5. %/@5. %@@@@ %%@@@ %4@@@ %4@@@ %4@@@ -@@@@ -%@@@ -4@@@ -.@@
5ther 5peratin
Bevenues
8n"lows "rom 5perations %/@5. %/@5. %/@5. %@@@@ %%@@@ %4@@@ %4@@@ %4@@@ -@@@@ -%@@@ -4@@@ -.@@
Total +urchases $-4.4 $4.== $4.== $4.== $=-.@ $;5=4 %@=@= %%@-% %%@-% %%@-% $=-.@ $=-.
)Accounts +ayable
Taken*
$-4.4 $4.== $4.== $4.== $=-.@ $;5=4 %@=@= %%@-% %%@-% %%@-% $=-.@ $=-.
Accounts +ayable +aid $=;;= $-4.4 $4.== $4.== $4.== $=-.@ $;5=4 %@=@= %%@-% %%@-% %%@-% $=-.
Feneral G Admin' !ash
5ut"lows
%;4@ -@.@ -$=@ -$=@ -$=@ -54@ -..@ -/=@ -;@@ -;@@ -;@@ -54@
5ther 5perational
5ut"lows
%-/. %5;% %5;% %5;% -%4@ -45. -./% -=== -=== -=== -%4@ -%4@
8nterest +ayments /$- .== 54- 54$ .$$ .55 /%% =-5 ;4$ $@4. $@%4 ;4/
Ta#es +aid -44/ %@@@ %@@@ %@@@
5ut"lows "rom %5@%/ $;=@4 %445@ %$@@$ %$/$; %=@$$ %/.-= %;-$$ -%/.$ -@=.. -@$;. %=@=
$;
Case Study
5perations
7on Term Debt Taken
!ash Sale o" Assets,
5ther
Con-5perational 8n"lows @ @ @ @ @ @ @ @ @ @ @
+lant G E3uipment %5@@ %5@@ %@@@
E#penditure
+ayment 7on Term
Debt
%.%= %.%=
Dividends +aid %5@@ %5@@
Con-operational
5ut"lows
@ @ %5@@ %5@@ %5@@ %.%= %@@@ @ %5@@ @ @ %.%=
Cet !ash 8n"low
)5ut"low*
%@%; /%5% $@. --5@$ -%%$; -..-; -5.-= -5-$$ -5%.$ $$-4 -=@4 5%=5
!ash 4alance 5%=- $$%5% 4$@. 4;; $/=$ -%.-; -$.-= -$-$$ -$%.$ 5$-4 /=@4 ;%=5
Short Term 7oans Taken @ @ @ -5@$ %%$; ..-; 5.-= 5--$ 5%.$ @ @
Short Term 7oans +aid $%=- /%5% $@. @ @ @ @ @ @ $$-4 -=@4 5%=5
Endin !ash 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@ 4@@@
Short Term Debt
5utstandin
$-/// .5%5 .4$; ;;$; %%$-= $=/// %44$5 %;/%. -4;=/ --=5- -@@4= %4/.
Short Term 7ine
Available
$5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@@ $5@@
E#cess )De"icit* o" 7ine $%%- =4/5 =5=$ 5@=$ %=.% --/// -;4$5 -
$4/%.
-
$;;=/
-
$==5-
-
$5@4= ;/.4
Summar/ o3 Assum)tions 3or 1678 Cas' In3$o9#Out3$o9 Bud"et
#alesI As per customer sales budget 9<<A on credit
A1 collectedI %rom 97CD9CJD balance sheet assume equal amount collected per month in
Oanuary %ebruary and -arch
A1 termsI 8< days
!nventoryI 99< days as in 98JD
+urchasesI ;:A of 2/# as per recent history
+urchase termI D< days but made one month in advance
2/#C#alesI B7A as in 98JD
#/A expensesI 97A of salesH assume :<C:< variableCfixed mix
Other op. outI 9:A component of 2/# for labor and overhead
!nterestI 7@A on short-term payable monthly in arrearsH D<A on long-term payable
monthly
TaxesI 98JD amount due in -archH 98J@ estimated paid quarterly in Oune #eptember
and =ecember
%@
Case Study
)T=I (o )T= takedowns on capital expendituresH semi-annual payments at end Oune
and =ecember as contracted
2apital exp.I 2apex B<<< &same as deprec' in April -ay and Ouly
=ividendsI :<<< as per customer indications
-inimum cashI As per customer indications now )cy @ million
*egin #T=I As per 97CD9CJD balance sheet
*efore continuing to the Orion 2ase #tudy complete +rogress 2heck D.7 which follows.
ORION INDUSTRIES
!n +art #ix of the case study Aries ties up some loose ends and analy6es the potential risks
associated with this credit. ,e weighs the risk against the opportunity and decides to recommend
the credit. %inally he decides on terms and conditions and structures the potential credit.
%oose Ends
2heckings from #agittarius *ank
At about the time that Aries was completing his numbers analysis )ibra *ank received favorable
checkings from #agittarius *ank. The report confirmed that Orion had been a customer for
several years and had a record for punctual payment. #agittarius was satisfied with the
relationship but Aries knew that this bank had serious liquidity problems and couldn"t sustain the
account. .Their loss is our gain5 thought Aries.
Kuality 2onfirmation from +A+
Aries was also able to obtain some information over the telephone from the +egasus Automobile
+lant"s procurement manager concerning the quality of Orion"s products and the company"s
reliability for timely delivery. The procurement manager reported .3e are pleased with the Orion
relationship. Their product is top quality and management is serious about on-time delivery
which helps us reduce our own inventory requirements. Orion continues to be one of our smaller
suppliers but we are pleased that they have agreed to increase their volume with us. 3e intend
to limit our suppliers to those that can best integrate their operations with ours.5
Aries noted the gist of the conversation in the reference section of the credit file. Although this
was a strong reference Aries was now thinking about the possible risks with the potential credit G
risks which must be considered along with the many positive factors for structuring a credit for
Orion.
Credit Riss
#mall 2ustomer *ase
3hile the +A+ procurement manager gave a good recommendation regarding quality and
timeliness he flagged a potential risk that Aries had not yet considered. The risk was that in an
economic downturn +A+ might view Orion as a marginal producer and eliminate the company as
a supplier. ,owever the strong economic situation the growing market demand and the
increased contract with +A+ seemed to neutrali6e this risk for the short term. Also Orion"s
production quality was some insurance against loss of the relationship with +A+ or with the
Tractor 3orks.
3hile Orion presently produced for these two principal customers there were other possibilities
as well. -ost of the less profitable relationships had been terminated by #corpio over the past
two years in order to focus on the more profitable clients. *ut #corpio had indicated that one of
their ma4or thrusts during the next two years was to diversify even more and search out new
buyers particularly in the export market. 3hile the current lack of a diversified customer base
was a situation to keep an eye on Aries decided that it was an acceptable risk.
!nsufficient -anagement =epth
Another credit risk appeared to be #corpio"s overall importance to Orion and ironically his grasp
of the company"s situation. #corpio tended to dominate the firm"s decision making to the point
%$
Case Study
where it could be considered a .one man show.5 Administrative management was stretched thin.
The Taurus brothers were important on the operational side but did not have the skills or interest
to manage effectively.
Aries had discussed this with #corpio and learned that two key people had been trained to
maintain the integrity of the cost accounting and management information systems which were
so crucial to the success of the firm. !n addition a new administrative manager would be hired
when operations started to expand. The risk of insufficient management personnel appeared to
be diminishing but it was something else to keep an eye on.
Overly Ambitious /oals
Aries also considered the related risk that perhaps #corpio"s goals were overly ambitious and he
was trying to achieve too much too soon. !t was possible he was overextending the company
and himself. Aries had 4okingly brought up the sub4ect with #corpio on one occasion. The
customer responded .+erhaps but our track record over the past two years shows that although
our balance sheet has shrunk rather than grown our profitability has grown tremendously. This
should give us some credibility on that score.5
Age of the +lant
The age of the plant could also be considered a risk especially considering the emphasis on
quality and timely delivery of Orion products. Aries had discussed this with #corpio who assured
him that with the addition of a few new machines the plant was capable of producing under their
contracted obligations. *ut #corpio did acknowledge that within a couple of years a new plant
with greater capacity would probably be necessary especially if additional contracts could be
obtained. This would either involve expansion or relocation.
Other 1isks
There were other risks such as potential problems with availability of raw materials &most were
produced domestically' and qualified labor but these risks were shared by practically all industrial
producers and had never hampered Orion in the past. 3orld petroleum prices were relatively low
at this time and were expected to remain low for the foreseeable future. Therefore fuel prices
were not expected to negatively impact domestic or international demand for automobiles at
least for the next several years.
#ince Orion no longer had any foreign currency debt devaluation was not a risk and the mini-
devaluations even helped Andromedan exports remain competitive. Auto production costs in
Andromeda were lower than in developed countries. Export of automobiles and parts had
become a ma4or potential source of foreign currency earnings and devaluation would probably
make these exports even more competitive G particularly since a ma4or portion of the components
was sourced domestically.
Ba$ancin" O))ortunities 9it' Riss
/rowing 2ompany
)eo Aries felt quite strongly that he had a solid potential credit. ,e liked Orion !ndustries because
it was a growing middle-si6e enterprise with a quality product in an improving market. The
company matched well with his unit"s target market definition and appeared to be a company with
continually growing needs. The situation was favorable for the bank to develop a mutually
beneficial solid relationship.
+rofessional Experienced +ersonnel
The management personnel at Orion were professional and experienced. They had a practical
focus high standards of quality and the ability to maximi6e their operation without frills or
excessive investment in plant and buildings. Their plans indicated an excellent potential
opportunity for the bank to finance the future plant relocation andCor expansion and to provide
letters of credit or other trade services for exports.
Kuality +roduct
Aries also thought about Orion"s product. There was a strong demand for parts in Andromeda"s
rapidly expanding automotive sector. !n addition Orion was able to produce other products
including the existing line of tractor parts. The tractor market was not growing as fast as the
automotive sector but continued to offer an attractive consistent demand for metal products.
Orion"s products had a strong reputation for quality and because of this the company should be
able to withstand an economic downturn.
#trong %inancial #ituation
%%
Case Study
The financial situation of the company was quite strong. The statements clearly reflected how
#corpio reduced the si6e of operations and made more efficient use of his assets. The company
became more profitable because margins were improved and interest expense was reduced by
the prepayment of long-term debt. The overall reduction in liabilities was accomplished by
reducing current assets and not by investing in new fixed assets. The balance sheet was quite
strong with a leverage of only <.;B on 97CD9CJD reduced by more than half in only two years.
,owever borrowing would reverse that.
#trong )eadership
!n particular Aries admired #corpio. The potential customer was an impressive person soft-
spoken but commanding of respect. ,e was a good manager with strong credibility established
by his impressive turnaround of the Orion financial situation. ,e was a rare combination of a
numbers and operations man with a strong grasp and attention to detail. ,e was a man that
Aries felt he could trust and work with comfortably.
Structurin" t'e Credit
Aries felt that #corpio"s request for a short-term line of credit with drawdowns up to a maximum
)cy @< million was the appropriate structure. The amount seemed high in relation to pro4ected
needs especially considering that /emini *ank currently offered about )cy 9: million in short-
term facilities. *ut Aries was willing to go with the amount in order to compete favorably with
/emini for the business and also to maintain a strong cushion of availability in case of
unexpected additional needs.
The bank operated under this mode with many other industrial enterprises and the structuring
worked quite well. The facility would permit the borrower to draw down as needed for a
determined period up to 9;< days or to discount receivables. The company to its own cash flow
cycle could ad4ust that way the borrowing.
ORION INDUSTRIES
Finis'in" Touc'es
Aries discussed the structure &proposed in +art #ix' with #corpio to confirm his agreement on the
details. !n general the customer was in agreement. .Although much of the time we"ll be
discounting receivables we prefer the flexibility of short-term loan availability as well. This will
see us through 4ust fine5 said #corpio.
#corpio balked at the DA spread and 9A commission as a negotiating tacticH but knowing this
was the market rate he finally accepted the terms. .(ext year we"ll be back asking you to reduce
the spread after you see how strong our balance sheet comes out5 said #corpio.
Aries said .! think we can work on this basis and !"ll start the approval machinery moving right
away Of course you reali6e this is not our final position until all approvals are obtained up the
line.5 The banker had to cover himself since credit seniors might make some changes or
additions to conditions on approval although he thought any changes would be minor. Aries felt
confident that this credit request would sail through the approval chain because it was a strong
credit and consistent with the type of client the bank wanted.
As the meeting between #corpio and Aries ended the client mentioned his concern about how
much longer this approval process would take. .!t"s already been about four weeks5 he said
.and now that we have the contract for increased production for +A+ we"ll need funds availability
soon. 2an we have a commitment from your bank in one week"s timeN5
Aries answered that this should be sufficient time. ,e knew that #corpio must be thinking in terms
of obtaining financial backstop availability very soon. !f something went wrong with the )ibra *ank
negotiations now #corpio would have very little time to patch something together with another
bank. *ut these were 4ust hypothetical problems figured Aries. .(othing will go wrong.5
Credit Paca"e
Aries had all of the elements of the credit package ready except for the credit memo which he
stayed late that night to finish. /iven the amount of exposure recommended for Orion Aries
%-
Case Study
knew that the credit would have to be approved by his department head and the #enior 2redit
Officer of the )ibra *ank who was at the second highest level below the *oard of =irectors.
3hen he had finished Aries left the credit package along with the credit file on the department
head"s desk. Aries had kept his credit supervisor informed of the progress with the potential
credit so the supervisor was familiar with the situation and was able to sign off on the credit
application quickly. The credit supervisor had provided some valuable thoughts during the
analysis phase and had participated in a couple of meetings with #corpio.
The credit package was then routed to the #enior 2redit Officer &#2O' of the )ibra *ank. Aries
had met with the #2O on two or three occasions and had been impressed with the depth of the
#2O"s credit knowledge which Aries thought fully 4ustified the #2O"s strong reputation.
Re+ie9 o3 t'e Credit Paca"e
The #2O"s policy was to read the material carefully once and make a quick decision one way or
the other. !f there were any loose ends to tie up he would discuss them with the author in person
and ask the credit officer to quickly ad4ust them. !f he agreed with the credit proposal he would
sign the 2redit +roposalCApproval form when this was done. !f there were fundamental problems
he would discuss them immediately with the author and see if a cure could be found. !f not the
credit would be disapproved.
On the following pages you will see a reproduction of the Orion credit
package. !t includesI
!redit +roposal:Approval 2orm,
4asic 8n"ormation Beport )48B*,
Addendum to 48B 1 Eanaement Assessment,
!omparative Statement o" 2inancial !ondition )spreads*,
!ustomer and Sensitivity +ro&ections,
!ash 8n"low:5ut"low 4udet,
Summary o" Assumptions "or $;<4 8n"low:5ut"low 4udet,
and
!redit Eemo'
-ost of this material has been developed in earlier parts of the Orion 2ase and is presented
again to demonstrate what a credit package looks like. 2arefully read the 2redit -emo on page
@-7@ to understand the style and methodology of the credit presentation and to be prepared to
answer subsequent questions for analysis.
%4
Case Study
%IBRA BAN2 CREDIT APPRO,A% NO( 78-:8.
2lientI ORION INDUSTRIES =ateI March 10, 19X4
)ocationI Perseus *ranchI Main
*usinessI Metal Products $nitI a!ital "oods
1evision =ateI 7; %ebruary 98J: 2lassificationI (one
2redit %acility and TermsI &)cy <<<"s'
Short#ter$ %ine o& redit G (ew %acility
AmountI )cy @<<<<
+urposeI #hort-term loans or discount of trade bills with recourse
+aymentsI !n full at maturity or as collected for trade bills
TenorI $p to 9;< days
!nterestI *ase rate or discount rate P DA p.a.
2ommissionI 9A flat on opening
2ommitment %eeI .7:A p.a. on undrawn facility
#upportI 9' )ien on trade receivables for 97<A of outstandings for loans
7' +ersonal guarantee of *. #corpio and -. and (. Taurus for
full amount of facility
D' )ife insurance policy in name of *. #corpio endorsed to bank
Existing Aggregate %acilitiesI &)cy <<<"s' Approved
None
#ecurityC#upportI
+ledge receivables from +A+ and AT3 for 97<A of outstandings duly
endorsed to bank &on loans'
2ontinuing )etter of /uarantee &2)/' signed by Orion to evidence
recourse on discounted trade bills
2)/ signed by *. #corpio and -. and (. Taurus for full amount of facility.
Approved AmountI %c/ 8:;:::;:::
2redit 2ommitteeI Area ,eadI #eniorsI *oardI
BASIC INFOR!ATION REPORT
+age 9
*1A(2,I %i'ra (an) Main =ATEI 7C9?CJ@ #!(2EI (CA
2)!E(TI Orion !ndustries *$#!(E##I -etal +roducts
A==1E##I +erseus O*TA!(E=I 1eference
%5
Case Study
O0NERSHIP
2losely held corporationI 7CD Taurus *rothers 9CD *runo #corpio latter with option for :9A
control. Employee stock ownership plan for 7<A out of Taurus *rothers holdings to be effected.
These independent ownerCmanagers are apparently highly committed.
DIRECTORS AND !ANA1E!ENT
/eneral
-anager
*runo #corpio early @<s mechanical engineer from $niversity of
Andromeda. Experienced in prior positions with subsidiaries of ma4or multi-
nationals. #trong background in manufacturing and costCmanagement
systems.
+roduction -ax and (ick Taurus late :<s immigrant founders self-made men.
Excellent craftsmen but not sophisticated managers.
-anagers have good reputation for reliability and integrity based on
feedback from suppliers etc.
HISTORY
2ompany was formed by Taurus brothers 7@ years ago to produce high precision metal parts.
,ave had ongoing and positive relationship with Andromeda Tractor 3orks and more recently
initiated higher precision production for +egasus Auto +lant. +roduct quality has been good but
spotty recent history in dependability and profits. Arrival of #corpio three years ago has helped
remedy this in productivity turnaround.
BAN2IN1 AND OTHER FINANCIA% RE%ATIONS
+rincipal bank has been /emini with some lending by #agittarius. )atter relationship being
terminated due to bank"s problems. /emini products include short-term lending occasional
equipment loans booked through Andromeda =evelopment *ank and payroll and current
account products. 1elationship has been unsophisticated due to lack of management financial
skill. 2heckings indicate good experience with occasional past rollovers.
OPERATIONS +age 7
+1O=$2T#
- ,igh precision metal works with variety of products
capability
- +rimarily tractor axle and transmissions
- (ow producing higher precision automobile universal
and rear axle assemblies
- #ome seasonality
- +erceived high quality workmanship
- #ales breakdownsI Tractor ::A G Automobile @:A
%A2!)!T!E#
- Own plant located in +erseus ?< km away
- Out of the way location but good access
- Own concrete block building free of mortgage
- Adequate energy and water infrastructure
- !mported machinery old but in good shape
- %ull insurance for depreciated market value
- 3arehouse controls adequate but crowded
- Employees appear to be well trained
- Employee relations good G good productivity
#$++)!E1#
A(= T1A=E
1E+$TAT!O(
- Andromeda #teel 3orks and Andromeda -ining and
-etals for local supplies of base metals
- Kuality of local supply is good
%.
Case Study
- Terms between D< and ?< days
- #ome purchases of foreign materials paid on cash basis
from free market foreign exchange
- 2heckings have been favorable
=!#T1!*$T!O(
A(= #E))!(/
TE1-#
- =irect sales to Andromeda Tractor 3orks and more
recently to +egasus Automobile +lant
- All sales on credit terms mostly 8< days
- Other miscellaneous sales &when spare capacity
available' with varying terms
- /ood references from AT3 and +A+ as to quality and
delivery timeliness
AFFI%IATED CO!PANIES AND RE%ATED BUSINESS
(o affiliated business
ADENDU! TO BIR4 !ANA1E!ENT ASSESS!ENT +age D
/OA)#
O1!E(TAT!O(
A(=
2O--!T-E(T
- /oals to produce more for the automobile sector
- +erception of ownerCmanagement commitment with
.hands on5 involved approach
- -anagement committed to quality serious
- 3orker productivity apparent with ongoing employee
stock ownership plan
- %irm now has more focused orientation since arrival of
#corpio
O1/A(!LAT!O(A)
2,A1A2TE1!#T!2#
A(= =E+T,
- %irm dependent on #corpio for managerial direction and
know-how
- Taurus brothers excellent craftsmen only
- +resent lack of depth
- (ew delegation system to develop new people
- +resent centrali6ed authority OM for level of operations
but not for growth into new products
*A2M/1O$(=
A(= )E0E) O% MEY
-A(A/E1#
- #corpio has strong manufacturing background with
particular strength in cost accounting and management systems for
tracking results
- #corpio experience gained with Andromeda subs of ma4or
multinationals
- Taurus brothers have strong background as craftsmen
with credibility for quality
- *rothers weak on administrative side
3O1M ,A*!T# A(=
-A1MET 1E+$TATO(
- 2ommitment to quality and excellence
- 1eputation for thoroughness and on-time delivery
although previously some problems
- 3ork force apparently well trained
- 3ork force motivated with productivity pay
- Employee turnover apparently healthy lower than normal
- %irm has good reputation for integrity
%/
Case Study
-A(A/E-E(T
#Y#TE-# A(=
2O(T1O)#
- (ew systems fill vacuum of prior management
- 2ost accounting systems have brought back profitability
vs. prior marginal results
- -anagement information systems track productivity and
work defects by product line
- *udgeting systems permit controlCdelegation
A22E## TO
TE2,(O)O/Y
- +roduct is craft but not .high tech5
- -achinery appears adequate for needs
- -achinery apparently maintained by own staff under
supervision of Taurus brothers
- Technology appears to be adequate
COMPARATIVE STATEMENT OF FINANCIAL CONDITION
Came: ORION INDUSTRIES 7ocation: ANDORMEDA
!urrency: LCY IN THOUSANDS Auditor: CAPRICORN & CENTAURI
Date: $%:-$:<$ $%:-$:<% $%:-$:<-
Cumber o" Eonths $% $% $%
Sales on !redit % $@@ $@@ $@@
BA%ANCE SHEET Actual Actual Actual
ASSETS
!ash $,;;/ $,/;% $,=54
Earketable Securities %,@@@ %,@@@ $,4@@
Accounts Beceivable ./,-5@ .$,=/% 54,$$4
8nventory /4,/%@ 5.,;/% 5-,4.=
5ther !urrent Assets 5,4/. %,.5@ 4,$%.
+repaid E#penses -,@$5 %,.5$ %,455 @
!urrent Assets $54,55= $%/,;-/ $$/,4$/
Cet 2i#ed Assets 44,/.% 4$,$%/ -=,4@.
8nvestments @ @ @
5ther Con-current Assets %,;=. 5,%4% .,$@/
8ntanibles @ @ @ @
Total Con-current Assets 4/,/4= 4.,-.; 44,5$-
@
Total Assets %@%,-@. $/4,-@. $.$,;-@ @
78A4878T8ES G EH98TI
Due 4anks, Short-term -;,.$5 -5,54% $5'@.@
Accounts +ayable %.,/%@ %@,4.= $=,;;=
Accruals $@,4%; =,@/% =,-==
Ta#es +ayable %-@ %,$$. -,44/
5ther !urrent 7iabilities
!urrent +ortion 7 T Debt /,$%@ 5,4-- 5,%55 @
!urrent 7iabilities =4,$$4 .=,.-$ 5$,$4=
7on-term Debt --,%4/ $.,45% $$,%-%
5ther 7iabilities, 7on-term $;,/;4 $%,/-% $%,;/@ @
7on-term 7iabilities 5-,@4$ %;,$=4 %4,%@%
@
Total 7iabilities $-/,$55 ;/,=$5 /5,-5@
!ommon Stock --,@@@ -@,@@@ -@,@@@
%=
Case Study
Surplus G Beserves %4,@@@ %4,4=$ %5,@=@
Betained Earnins $$,$5$ %%,@$@ -$,5@@ @
Total Cet (orth .5,$5$ /.,4;$ =.,5=@
@
7iabilities G Cet (orth %@%,-@. $/4,-@. $.$,;-@ @
%;
Case Study
Came: ORION INDUSTRIES
Date: $%:-$:<$ $%:-$:<% $%:-$:<-
INCO!E STATE!ENT Actual Actual Actual
Cet Sales %//,=./ %/@,%-= %4-,5@4
!ost o" Foods Sold %$-,-@. %@%,5%= $/5,-$@
% o" Sales /.'= /4'; /%'@
Sellin, Feneral, Admin' E#pense -=,;/% -%,5.. -@,=;.
% o" Sales $4'@ $%'$ $%'/ @
Fross Earin %5,5=; -5,$44 -/,%;=
% o" Sales ;'% $-'@ $5'-
Depreciation 5,$%$ 5,-/4 .,5-;
8nterest E#pense $=,=.% $-,-%/ $@,/.@
5ther 8ncome:)E#penses*, Cet -./ -$44 -;= @
Earnins 4e"ore Ta#es $,5-; $.,%;; $;,;@$ @
% o" Sales @'. .'@ ='%
8ncome Ta#es -@4 4,;5; .,=..
E#traordinary 8tems @ @ @ @
Cet 8ncome $,%-5 $$,-4@ $-,@-5
% o" Sales @'4 4'% 5'4 @
RATIOS 7Annu#&i8ed9
Sales Frowth Bate % -%'/ -;';
Cet 8ncome:Averae Cet (orth % $'; $.'@ $.'@
Cet 8ncome:Averae Assets % @'. .'@ /'=
Sales:Averae Assets $'-/ $'44 $'45 @
!urrent Batio $'= $'; %'-
Huick Asset Batio @'= $'@ $'$
Days Beceivables =/ =% =@
Days 8nventory $%. $@$ $$@
Days +ayable 45 -. -; ;
7everae )Debt:E3uity* %'$$ $'%= @'=/
7on-term 7everae @'=$ @'-= @'%= 4
RECONCILIATIONS
Cet (orth
4einnin Cet (orth C:A .5,$5$ /.,4;$
+lus: Cet 8ncome $,%-5 $$,-4@ $-,@-5
+lus: 2resh !apital @ @
Total 8ncrease $$,-4@ $-,@-5
7ess: Dividends, 5ther @ %,;4.
8ncrease:Decrease in C( $$,-4@ $@,@=;
Endin Cet (orth .5,$5$ /.,4;$ =.,5=@ @
2i#ed Assets
4einnin 2i#ed Assets C:A 44,/.% 4$,$%/
7ess: Depreciation 5,$%$ 5,-/4 .,5-;
Subtotal -;,-== -4,5==
Endin 2i#ed Assets 44,/.% 4$,$%/ -=,4@.
!apital E#penditure ' $,/-; -,=$= =
Came: ORION INDUSTRIES
Date: $%:-$:<$ $%:-$:<% $%:-$:<-
-@
Case Study
Cumber o" Eonths $% $% $%
CASH 1ENERATION Actual Actual Actual
Cet 8ncome $,%-5 $$,-4@ $-,@-5
Depreciation 5,$%$ 5,-/4 .,5-;
5ther Con-!ash !hares C:A @ @
Fross 5peratin 2unds Feneration .,-5. $.,/$4 $;,5/4
8ncrease in !ash G Earket Securities -%@5 -5-=
8ncrease in Accounts Beceivable -5,4/= -/,/5=
8ncrease in 8nventory -$/,/4= --,5@4
8ncrease 5ther !urrent Assets -%,=%. $,4/.
8ncrease +repaid E#penses ' --.4 -$;.
Total 5peratin Ceeds ' -%.,.%$ -$@,5%@
8ncrease in Accounts +ayable -.,%5% -$,4/@
8ncrease in Accruals -%,-5/ -$.
8ncrease Ta#es +ayable $,==. $,--$
8ncrease 5ther !urrent 7iabilities ' @ @
Total 5peratin Sources ' -.,/%- $//
Cet 5peratin !ash Feneration ' -.,.$% -@,%/$
!apital E#penditures $,/-; -,=$=
Dividends @ %,;4.
8ncrease in 8nvestments @ @
8ncrease 5ther Con-!urrent Assets %,%5. =.5
8ncrease in 8ntanibles @ @
Beduction Short-term 4ank Debt /,@/- $/,4=%
Beduction 7on-term Debt ' $=,4=% 5,-;=
Total Con-5peratin Ceeds ' %;,55@ -@,5@;
2resh !apital:5ther C( 8ncrease @ @
8ncrease 5ther 7on-term 7iabilities -/,@.% %-=
8ncrease Short-term 4ank Debt @ @
8ncrease 7on-term Debt ' @ @
Total Con-5peratin Sources ' -/,@.% %-=
J !heck )C5!F 1 TC5C K TC5S* ' @ @
Q 2heck &(et Operating 2ash /eneration G Total (on-operating (eeds P Total (on-operating
#ources'
Came: ORION INDUSTRIES
Date: $%:-$:<$ $%:-$:<% $%:-$:<-
Cumber o" Eonths $% $% $%
SUPP%E!ENTARY INFOR!ATION
Cet 2i#ed Assets 4reakdown
7and .,/%$ .,/%$ .,/%$
-$
Case Study
4uildins %$,5%@ %$,5%@ %4,@-.
Eachinery G E3uipment 4$,-=/ 4-,5%% 44,5./
Lehicles $,/./ $,-/$ $,.%=
Subtotal /$,-;5 /-,$-4 /.,;5%
7ess: Accumulated Depreciation %.,.-- -%,@@/ -=,54.
Cet 2i#ed Assets 44,/.% 4$,$%/ -=,4@.
Due 4anks, Short-term
Femini 4ank $-,;4/ $/,44@ $5,@.@
Saittarius 4ank $4,5/$ ;,.55 @
Ac3uarius 2inancial $$,@;/ 5,44/ @
-;,.$5 -%,54% $5,@.@
7on-term Debt
Femini 4ank .,4%% 5,%/. 4,$-@
Saittarius 4ank ;,=%/ .,-44 -,$5$
Andromeda Develop 4ank %4,$$= $@,%.5 ;,%@.
4@,-./ %$,==5 $.,4=/
7ess: !urrent +ortion /,$%@ 5,4-- 5,%55
--,%4/ $.,45% $$,%-%
8nventory
2inished Foods %-,.-@ $.,@-% $;,-//
(ork in +rocess 4,4%- %,4.$ -,=55
Baw Eaterial 4.,../ -=,4/; -@,%-.
/4,/%@ 5.,;/% 5-,4.=
-%
Case Study
CLIENT AND SENSITIVIT: PRO;ECTIONS
ORION INDUSTRIES
$% month
Actual
$% month
!ustomer
$% month
Sensitivity
Thousands o" 7cy $%:-$:<- +ro&ection +ro&ection
BA%ANCE SHEET
!ash G Earketable Securities -,%54 4,@@@ -,@@@
Accounts Beceivable 54,$$4 /-,@5$ =$,$.=
8nventory 5-,4.= /$,-$. =%,;54
5ther !urrent Assets 4,$%. 4,$%. 5,@@@
+repaid E#penses %,455 %,455 -,@@@
!urrent Assets $$/,4$/ $54,;4= $/5,$%$
Cet 2i#ed Assets -=,4@. -.,4@. -=,4@.
8nvestments @ @ @
5ther Con-current Assets .,$@/ /,$@/ /,$@/
8ntanibles @ @ @
Con-current Assets 44,5$- 4-,5$- 45,5$-
T5TA7 ASSETS $.$,;-@ $;=,4.$ %%@,.-5
4ank Debt, Short-term $5,@.@ $=,/4/ .-,4@.
Accounts +ayable $=,;;= %5,;-- $/,//.
Accruals =,-== $-,@@@ $$,@@@
Ta#es +ayable -,44/ 5,@@@ 4,@@@
5ther !urrent 7iabilities @ @ @
!urrent +ortion 7 T Debt 5,%55 5,%55 5,%55
!urrent 7iabilities 5$,$4= ./,;-5 $@$,4-/
7on-term Debt $$,%-% 5,;// 5,;//
5ther 7on-term 7iabilities $%,;/@ $.,@@@ $5,@@@
T5TA7 78A4878T8ES /5,-5@ =;,;$% $%%,4$4
!ommon Stock -@,@@@ -@,@@@ -@,@@@
Surplus and Beserves %5,@=@ %5,.=@ %5,.=@
Betained Earnins -$,5@@ 5%,=.; 4%,54$
T5TA7 CET (5BT0 =.,5=@ $@=,54; ;=,%%$
78A4878T8ES G CET (5BT0 $.$,;-@ $;=,4.$ %%@,.-5
$%:-$:<- !ustomer Sensitivity
INCO!E STATE!ENT
Cet Sales %4-,5@4 -%=,/-@ %;%,%@5
!ost o" Foods Sold $/5,-$@ %--,-;; %$-,-$@
% o" Sales /%'@ % /$'@ % /-'@ %
Sellin, Feneral, Admin' E#penses -@,=;. -/,=@4 -/,;=/
% o" Sales $%'/ % $$'5 % $-'@ %
--
Case Study
Fross Earin -/,%;= 5/,5%= 4@,;@;
% o" Sales $5'- % $/'5 % $4'@ %
Depreciation .,5-; /,@@@ /,@@@
8nterest E#pense $@,/.@ $%@@@ $.,@@@
5ther 8ncome, Cet -;= @ @
Earnins 4e"ore Ta#es $;,;@$ -=,5%= $/,;@;
% o" Sales ='% % $$'/ % .'$ %
8ncome Ta#es .,=.. $$,55= .,%.=
Cet 8ncome $-,@-5 %.,;.; $$,.4$
% o" Sales 5'4% ='% % 4'@ %
RATIOS 7Annu#&i8ed9
Sales Frowth Bate % -;'; % -5'@ % %@'@ %
Cet 8ncome:Averae Cet (orth % $.'@ % %/'. % $%'@. %
Cet 8ncome:Averae Assets % /'= % $5'@ % .'$ %
Sales:Averae Assets $'4 $'= $'5
!urrent Batio %'- %'- $'/
Huick Asset Batio $'$ $'$ '=
Days Beceivables =@ =@ $@@
Days 8nventory $$@ $$@ $4@
Days +ayable -; 4@ -@
7everae @'=/ @'=- $'%5
7on-term 7everae @'%= @'%@ @'%$
RECONCILIATIONS
Cet (orth
4einnin Cet (orth /.,4;$ =.,5=@ =.,5=@
+lus: +eriod Cet 8ncome $-,@-5 %.,;.; $$,.4$
+lus: 2resh !apital @ @ @
Total 8ncrease $-,@-5 %.,;.; $$,.4$
7ess: Dividends, 5ther %,;4. 5,@@@ @
Cet 8ncrease:Decrease $@,@=; %$,;.; $$,.4$
Endin Cet (orth =.,5=@ $@=,54; ;=,%%$
2i#ed Assets
4ein Cet 2i#ed Assets 4$,$%/ -=,4@. -=,4@.
7ess: Depreciation .,5-; /,@@@ /,@@@
Subtotal -4,5== -$,4@. -$,4@.
Endin Cet 2i#ed Assets -=,4@. -.,4@. -=,4@.
!apital E#penditure -,=$= 5,@@@ /,@@@
5B85C 8CD9STB8ES $% months
Actual
$%:-$:<-
$% months
!ustomer
+ro&ection
$% months
Sensitivity
+ro&ection
-4
Case Study
Financia$ co+enants %inancial covenants may cover specific targets forI
minimum current ratio
minimum working capital
maximum leverage
minimum capitali6ation
minimum profitability or
others.
Events of Default and Acceleration
E+ents o3 de3au$t
The contract must specify which acts or omissions by the borrower constitute
events of default and what specific remedies the creditor may have &e.g.
disposition of pledged assets'. The first and most obvious event of default is
non-payment. *ut others must be clearly identified within the loan contract and
may includeI
proving any representation or warranty made by the
borrower to be materially false
non-compliance with any covenant
non-compliance with obligations under any other
contract &the so called cross-default clause'
placing of any 4udicial lien or embargo against any of the
borrower"s assets or
occurrence of bankruptcy insolvency or similar
conditions.
O)tion to acce$erate
re)a/
ment
5ne o" the basic premises o" the term loan document is the leal ability to accelerate the
borrower,s repayment obliations' 8" the borrower "ails to comply with all pertinent
clauses )e'' i" an event o" de"ault as speci"ied should occur*, the creditor has the leal
option to accelerate the maturity o" the loan'
8n practice, there is o"ten considerable "le#ibility e#ercised by the creditor when there is a
breach o" covenants' 8n many situations involvin de"aults other than payment de"aults,
the borrower is normally iven time to >cureA the de"ault' 8n more serious situations, i"
the de"ault is in ood "aith, the creditor may reneotiate terms' Even i" it is rarely used,
the bank,s leal riht to accelerate ives it neotiatin powers with the borrower, and
perhaps with other creditors'
ORION INDUSTRIES P#rt <
Introduction
8n +art Eiht o" the 5rion case, the Senior !redit 5""icer approved the loan a"ter re3uestin an industry
analysis to determine business sector risks with the credit'
(e now proceed to +art Cine' A"ter the disbursement and establishment o" a credit relationship, the
customer asks the bank to provide e3uipment "inancin "or new machinery' The bank approves the re3uest
and has to structure a term loan document'
Credit Re&#tion$hi)
5rion utili6ed the 7ibra 4ank short-term "acility durin the middle months o" the year when the company
bean producin additional 3uantities "or the +easus Automobile +lant' 9se o" the "acility was heavier
than 5rion had anticipated because receivables and inventories remained at slihtly hiher levels than
oriinally anticipated in the customer,s pro&ections, but in line with the additional 7cy $@ million that was
-5
Case Study
identi"ied in the sensitivity "iures' +ayment e#perience was ood, repayment o" advances was timely, and
there were no di""iculties collectin discounted bills'
The overall "inancial situation o" the "irm was 3uite sound, and the 3uarterly "inancial statements veri"ied
that leverae was below $'@@' +ro"itability was maintained at the level anticipated in the optimistic
pro&ections and Scorpio,s credibility was con"irmed as actual pro"it numbers closely matched earlier
pro&ections'
7eo Aries maintained "re3uent contact with 5rion' This allowed him to provide ood service to the
customer and to anticipate additional needs, such as cash manaement products in con&unction with
collection o" 5rion receivables' 8t also provided a deeper understandin o" the business sector, which the
bank used to re"ine the risk asset acceptance criteria and identi"y potential bankin relationships in that
sector' in "act, two other potential relationships that sur"aced "rom the industry study were now bein
analy6ed within 7ibra 4ank'
!o+ Lo#n Re=ue$t
Aries kept track o" 5rion,s cash needs and o""ered to study any new proposals that miht come alon "or
e3uipment "inancin' Scorpio then asked 7ibra 4ank to consider a 7cy .@ million packae "or replacin
some old e3uipment, addin new machinery, and constructin a new win to house the new machinery'
Total cost o" the 5rion pro&ect was estimated to be 7cy =@ million'
2unds were to be sourced "rom a special "und o" the Andromeda Development 4ank "or e3uipment imports,
and the loan was to be booked throuh 7ibra in 7cy' The approved tenor within this proram was "or "ive
years' Scorpio thouht that the machinery could be installed and workin within si# months o" orderin'
4ecause Aries had come to know the company so well, and had maintained updated "inancial in"ormation,
the banker was able to 3uickly put toether "ive year pro&ections "or the company to complement the
"orecast iven by 5rion' The realistic scenario o" the pro&ections indicated a cash eneration availability
"or lon-term debt reduction o" 7cy $=-%@ million per year, beyond the present annual needs o" 7cy 5'-
million'
Despite his earlier e#perience o" havin been overcon"ident with the oriinal 5rion credit approval, Scorpio
"elt that the new credit recommendation would sail riht throuh approval channels' The bank had a better
understandin o" auto parts producers and had identi"ied this sector as a prime rowth area' Also, 5rion
was now an established credit relationship within the bank' As a matter o" "act, the account plan "or 5rion
called "or e#plorin these term "inancin needs which had been anticipated since the initial credit approval'
Ter. Lo#n Structuring
!ommitment 7etter
7eo Aries, task now was to structure a deal to recommend "or approval in an updated credit packae'
Speci"ically, his task was to write up a commitment letter that would contain all the pertinent details o" the
proposed term "inancin, includin all conditions and covenants' 0e would include the commitment letter
in the credit approval packae and, once approved by the bank and the customer, it would serve as the basis
"or the bank,s lawyer to dra"t the necessary term loan documentation'
The commitment letter bean as "ollows:
Borrower: 5rion 8ndustries, 8nc'
Lender: 7ibra 4ank
Funds Source: E3uipment "inancin "acility o" the Andromeda Development
4ank
Amoun: 7cy .@,@@@,@@@
Pur!ose E3uipment "inancin
Tenor: 5 years, includin $ race
P"#mens: Huarterly installments beinnin $% months a"ter sinin
loan documents
Ineres: AD4 "loatin base rate K 4% p'a', payable 3uarterly in
arrears
Comm$men Fee on
Unused B"%"nces:
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M% p'a' on undrawn balances
Ne&o$"$on Fee: $% paid upon sinin loan documents
A'"$%"($%$#: 9p to . months a"ter sinin documents
Co%%"er"%: $* 7ien on machinery to be ac3uired )worth appro#imately
7cy 45 million*
%* 7ien on e#istin machinery and mortae on new
construction with combined value o" 7cy %5 million
Terms and !onditions
The banker had to "urther de"ine appropriate terms and conditions "or the potential term loan that would
minimi6e the risk to the bank and also would be commercially acceptable to the borrower'
The clauses should cover:
representations and warranties
conditions precedent
affirmative covenants
negative covenants
financial covenants and
events of default.
The following are suggested clauses to be included within the loan agreement. #ome of these
clauses are basic to all agreements while others are specifically tailored to the Orion situation.
The list is not exhaustive and other clauses could be appropriate.
Re!resentations and
*arranties+
#tandard representations as toI
- powers legal incorporation
- ownership of fixed assets
- no prior existing liens
- financial situation of the company
is as depicted in audited financial statements
- no lawsuits pending and
- schedule of company ownership
- -A2 clause
- use of proceeds
That the company has an existing contract with +A+
and AT3
This last warranty is pertinent to the situation because the contracted output is important to
reduce the risk with the credit. Other representations are standard in nature.
ondition Precedent+ That Orion must invest its )cy 7< million in the new
pro4ect prior to the bank"s obligation to provide funds
under the contract.
This may be accomplished by some sort of escrow agreement or deposit of funds by Orion with
the bank. !t is standard practice that the borrower should invest its funds prior to the bank"s
advances.
,&&ir$ati-e o-enants+
Orion is obliged to keep its contracts with the +A+
and AT3 valid and in force.
All insurable physical assets of the company are to
be duly insured.
All assets mortgaged or otherwise given in lien to
the bank must be duly insured with the bank named
as beneficiary.
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The company must provide the bank quarterly
financial statements within ?< days of the end of each
respective quarter.
The company must provide the bank with annual
financial statements audited by an external auditor
acceptable to the bank within 8< days of fiscal year
end.
The company must maintain all other financial
obligations up to date.
The basic idea of the affirmative covenants is to maintain the status quo of the company"s
operations and relations with the bank and to permit the bank to maintain its control over the
situation.
Another possible covenant here might be to obtain key-man life insurance with the bank as
beneficiary. ,owever this is already required under terms of the short-term line and Orion has
insurance coverage of fixed assets for the term portion of the credit relationship with the bank as
loss payee.
Ne"ati-e
o-enants+
3ithout the bank"s prior written consent Orion will notI
- merge any other company or enter into
new lines of business.
- sell otherwise dispose of any fixed assets
in excess of the amount of annual depreciation.
- change the general manager.
- pay any dividends in amounts greater than
what is needed to comply with the existing share
purchase agreements G- which cannot exceed G- amount
in any one year.
)ike affirmative covenants the basic idea of the negative covenants is to preserve the
attractiveness of the borrower to potential lenders. !n addition they attempt to prevent the
company"s risk profile from deteriorating. 3hen a bank has decided based on a defined risk
profile to grant a term loan it uses the negative covenants in the contract to preserve the
situation.
The limitation on capital expenditures is negotiated with the customer. The cap utili6ed here &the
amount of depreciation for the year' is a fairly standard device. !f there will be ongoing
investments beyond the purchases financed by this term loan the amounts should be negotiated
with the customer and listed.
The same applies to the amount of the dividend. The limitation should be measured and
negotiated with the customer and stipulated clearly within the loan agreement.
.inancial o-enants+ Orion pledges to maintainI
- a minimum current ratio of 9.; as
measured at the end of each quarter.
- a maximum leverage of 9.: as
measured at the end of each quarter. %or
purposes of measuring this index any
contingent liabilities from corporate guarantees
should be included within the computation as if
these were liabilities of the company.
!n the financial covenants all financial terms such as current ratio and leverage should be defined
within the loan contract to avoid misunderstanding. %or example current liabilities &for the current
ratio definition' should specify that all outstandings under all credits should be included &as they
may be sub4ect to acceleration' and the minimum current ratio should be reduced accordingly.
Other financial covenants could be used to specify minimum working capital &which also should
be defined' or capital requirements although these are implicitly covered by the two ratios above.
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*ut sometimes these latter two measures can be included separately as well. !t may depend on
the specific needs of the bank or on negotiations with the customer.
E-ents o& De&ault+ The bank may declare its obligations under this loan
agreement terminated and all outstandings
immediately due upon the occurrence ofI
- non-payment of any principal or
interest when due.
- proof that any representation made
is false in any material way.
- non-compliance with any of the covenants.
- non-compliance with any obligations under any
other contract &cross-defaultQ'.
- a 4udicial lien or embargo placed against any of
the borrower"s assets.
- bankruptcy or insolvency of the borrower.
Q The cross default is a useful device for the bank to insure that if any problems occur with
another credit the bank may also accelerate the maturity of its loan. This clause is very useful
to maintain payment discipline and to protect the bank"s interest in relation to other creditors. !t
is not to be confused with the cross-acceleration clause which only gives the creditor the right
to demand acceleration if another creditor accelerates.
.
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