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What is credit & its need ?

The type of credit facilities

Evaluation of Credit Facilities Taking Decisions relating to credit

Importance of Quality Credit

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A contractual agreement in which a borrower receives something of value now and agrees to repay the lender at some later date.
Lender Credit Period $ Borrower $ Time Lender

Consumer Lending Corporate /Commercial Lending

By way of

Direct advances
i.e. Fund based

Indirect advances
i.e. non fund based advances

Loan ( Short Medium Long) Overdrafts Letters of Credit, Revolving Loans & Acceptance, Shipping Guarantees Export Finance Import Finance Pledge Loans & Trust Receipts Guarantee Facility Leasing & hire purchase

To bridge working capital requirements. Interest is to be calculated daily, debited monthly. Renewed periodically. Bank has no control over the usage of funds.
Generally Used For? Not used for ?

Generally used to finance Capital Expenditure although not always. (Eg-: Fixed working

capital requirements)

To be repaid over a an agreed period of time, i.e. the outstanding gradually diminishes. To be granted for specific purposes. Long Term, Medium Term & Short Term.

A contingent liability created by one bank to another. Commission based. Mostly used for foreign trade & in dealing with unknown parties.
Acceptance facilities ( usance period)

Revolving loans are granted to finance particular trade or order cycles. They are short term in nature and coincide with the working capital cycle of a client.
Examples ?
Importers Traders : Buying & Selling.

Export Bill Purchases and Export Loan Facilities.

Export Bills submitted by the exporter which are then purchased by the bank. Export Loans are granted to facilitate the preshipment requirements ( packing credit loans).

Finance against Bill Acceptance Finance against Imported Merchandise Payment Against Documents

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Pledge Loans are advances made against the pledging of a certain item as security. Either in the total contol of the F/I or with dual control between the borrower and the F/I. In Trust Receipts the title ( ownership) to the goods are surrendered to the F/I.

A promise made by a bank to another bank, lender or counterparty to pay a liability of the borrower based on the outcome of a particular event/activity. The beneficiary is always a third party.
Financial Guarantees Bid Bonds Advanced Payment Guarantees Performance Guarantees Retention Guarantees.

Advances made against post dated cheques & approved bills. Commission Based, expensive to borrower , risky to F/Is.

A lease is a contract calling for the lessee (user) to pay the lessor (owner) for use of an asset. A finance lease is a commercial arrangement where: the lessee (customer or borrower) will select an asset (equipment, vehicle, software); the lessor (finance company) will purchase that asset; the lessee will have use of that asset during the lease; the lessee will pay a series of rentals or instalments for the use of that asset; the lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee; the lessee has the option to acquire ownership of the asset (e.g. paying the last rental)

A method of buying goods by way of making instalment payments over time. Involves a down payment. Rentals are paid on a periodical basis.

Credit Evaluation

Marketing new business Appraisal & Preparation of credit Report Recommendation Acceptance & Completion of securities Granting / disbursement Monitoring and recovery Retention Or Litigation

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Existing & New. Goals of the Bank Vs. Needs of the customer. Profit Vs. Risk. Ability to ensure a proper service. Information Acquisition & Documentation
the first attack is half the battle

Two possible risks prior to a credit accommodation :

Default due to failure Willful default.

50% of your total risk is mitigated by identifying a potential willful defaulter.

Credit Appraisal Process

Background & Management Analysis Financial Analysis. The demand Vs. Need. Viability of the business Capacity to repay. Market Analysis, Industry Analysis. Previous Track Record ECIB & Data Check, informal sources. Risk mitigants Adequacy of Collateral Security Pricing and special conditions

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 The

nature of business. The History Product Range. Subsidiaries & Related Parties Present Banking Facilities.

Who the key people? ( owners & management) Their backgrounds.

Educational Social Industry experience Financial

Any other important disclosures eg: related parties, known addictions.

The two key factors for business survival: Profitability Solvency

Profitability is important to measure the viability/practicality of pursing the business. The solvency of a business is important because it looks at the ability of the business in meeting its financial obligations

 The nature of advance requested.

-Understanding the Various Types of Advances.

The size of the advance requested.

What are the implications of an improper facility?

Inability to complete the project or carry out business. Inability to face volatilities. Hampers growth, loss of confidence. Excessive debt service burden. Loss of Efficiency. Over confidence.

Income Income Income Income

Source Amount Consistency Continuity

Sensitivity Analysis
Cash Flow Statement & DSCR Calculation

Position of the Borrower in the market (SWOT).

The present standing of the business. The existing market share (local /Global). Competitors / barriers to entry. What differentiates the client from the rest.

The industry outlook

The government support General Industry. Identifying Sunshine industries.

Previous Repayment Patterns. CIB Reports. Status Reports from other banks. D & B for foreign parties. Informal Sources.

Should be Liquid. Identification. Standardization

Stability of Value & Durability

Cash Government Securities Letter of Guarantee Life Insurance Policies Share Certificates Immovable Items Land, Building & Fixed Machinery. Moveable Items- machinery, vehicles Lease Hold Rights. Stocks & Book Debts. Trust Receipts & Pledged Items. Promissory Notes. Personal & Corporate Guarantees.

Inhernt/ Internal qualities of your client.

Eg:-

Additional Collateral. Excess Production Capacity. Experience & Contacts. Management & Financial Stability. Diverse Range of Products.

The loan should be priced based on the amount of Risk the bank takes. Special Conditions should be incorporated to mitigate possible risks.
Cash Build Ups. Periodical stock statements/ visits.

Your Recommendations

It is important to follow up and ensure the completion of security soon.

Avoid any changes that may affect your approved proposal. To avoid the client from leaving you. Reputational Risk

Either way swift action is required. This is what frames the future.

Provisioning on Profits. Affects the Image of the Bank Negatively: Reputational Risk which may lead to other risks.

CCCPARTS- Character, Capital, Capability, Purpose, Amount, Repayment Terms and Security PARSER Person, Amount, Repayment, Security, Expediency, Remuneration

CAMPARI - Character, Ability, Margin, Purpose, Amount, Repayment , Insurance

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Evident Repayment Capacity. Quality Collateral. High Integrity or Previous Track Record (unblemished trust) Pressure?

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C C C C C

- Character - Capacity - Capital - Collateral - Conditions

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The lender will form a subjective opinion as to whether or not the borrower is sufficiently trustworthy to repay the loan or generate a return on funds invested in your company. The educational background and experience in business and industry of the borrower will be reviewed. The quality of the borrowers references and the background and experience levels of the management and employees of the borrowers business also will be taken into consideration.

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to repay is the most critical of the five factors. The lender will want to know exactly how the prospective borrower intends to repay the loan. The lender will consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on existing credit relationships -personal or commercial -- is considered an indicator of future payment performance. Lenders also want to know about the borrowers contingent sources of repayment.

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It is the money the borrower has personally invested in the business and is an indication of how much the borrower has at risk should the business fail. Lenders expect borrowers to have contributed from their own assets and to have undertaken personal financial risk to establish the business before asking them to commit any funding.

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Collateral or guarantees are additional forms of security to be obtained from the borrower. Giving a lender collateral means, pledge an asset of the borrower, such as land, building, machinery etc, to the lender with the agreement that it will be the repayment source in case the borrower cant repay the loan. A guarantee, on the other hand, is when a 3rd party signs a guarantee document promising to repay the loan if the borrower can't. Lenders at time try to secure themselves with both the above options.

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It focuses on the intended purpose of the loan. Will the money be used for working capital, additional equipment, or inventory? The lender also will consider the local economic climate and conditions both within the borrowers industry and in other industries that could affect his business.

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Credit application form duly perfected (Every subsequent request should be followed by a written request from the client) Company profile nature of business, products, Registration documents (form 13/20 & 40 duly certified ), M & A , key people Borrowers Audited financial statements & the latest management financials Declaration of facilities with other Financial institutions Visit Report

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Early warning signals can be identified from Early Management Warning Signals. Sales Returns ( quality issues). Staff Morale. Market & Industry Failures Receivable aging Early banking warning signals

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Cheque returns Regular Temporary accommodation requests Delaying repayments Operate over the approved limits Personal drawings Heavy reliance on short term debt Frequent change of business etc

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Lending is an art, You must understand the need of the client and the need of the Bank No Risk No Profit Your decisions should be based on striking the balance between these two. End of the day it should be a win win situation for both the client and the bank.

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Collateral is only a spare wheel. Quality of your loan portfolio is more important than volume of the loan portfolio. Lending is only the start.

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The F/I are accountable for every cent that is lent. The money lent is not your own! Never be in a hurry to lend, because a defaulter will never be in a hurry to repay.

The regulator is there to help & guide you. It is your duty to support the stability of the financial system.

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Purpose: To use financial organisations

statements

to

evaluate

an

To have a means of comparative analysis across time in terms of:

Intracompany basis (within the company itself) Intercompany basis (between companies) Industry Averages (against that particular averages) industrys

Financial performance Financial position.

To apply analytical tools and techniques to financial statements to obtain useful information to aid decision making.

Financial statement analysis involves analysing the information provided in the financial statements to:
Provide information about the organisations:
Past performance Present condition Future performance

Assess the organisations:

Earnings in terms of power, persistence, quality and growth Solvency

Requires that you: Understand the nature of the industry in which the organisation works. This is an industry factor. Understand that the overall state of the economy may also have an impact on the performance of the organisation.

Financial statement analysis is more than just playing with numbers; it involves obtaining a broader picture of the organisation in order to evaluate appropriately how that organisation is performing

To perform an effective financial statement analysis, you need to be aware of the organisations:
business strategy objectives annual report and other documents like articles about the organisation in newspapers and business reviews. These are called individual organisational factors.

The dates and duration of the financial statements being compared should be the same. If not, the effects of seasonality may cause erroneous conclusions to be drawn. The accounts to be compared should have been prepared on the same bases. Different treatment of stocks or depreciations or asset valuations will distort the results. In order to judge the overall performance of the firm a group of ratios, as opposed to just one or two should be used. In order to identify trends at least three years of ratios are normally required.

Balance Sheet, Income Statement /P&L, Cash Flow

Liquidity Analysis give a picture of a company's short term financial situation or solvency. Operational/Turnover Ratios show how efficient a company's operations and how well it is using its assets. Leverage/Capital Structure Ratios show the quantum of debt in a company's capital structure. Profitability & Performance Analysis use margin analysis and show the return on sales and capital employed.

Working capital management is important as it signals the firms ability to meet short term debt obligations.

Working Capital = Current Assets Current Liabilities

Current Ratio = Current Assets / Current Liabilities Quick Ratio = Quick Assets / Current Liabilities

Efficiency of asset usage

How well assets are used to generate revenues (income) will impact on the overall profitability of the business.

Debtors Turnover Ratio = Net Credit Sales / Average Debtors Average Collection Ratio = Months (days) in a Year / Debtors Turnover

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

Volume Return

Improvement

Reduction

Sales Growth = Change in sales / previous years sales * 100 Gross Profit Margin = Gross Profit/ sales * 100 Net Profit Margin = Net Profit / sales * 100 Return on Capital Employed= (EBIT / Capital Employed) * 100 Return on equity = (Net profit after taxes) /Shareholders' equity *100 EPS = Net Profits Available to Equity Holders / Number of Ordinary Shares Outstanding

Measures the amount of risk for the business in terms of debt gearing.

Interest Coverage Ratio = EBIT/ Interest Expense Debt Service Cover Ratio = PAT + Depr. + Annual Interest on Long Term Loans & Liabilities --------------------------------------------------------------------------------Annual interest on Long Term Loans & Liabilities + Annual Installments payable on Long Term Loans & Liabilities

Debt to Equity Ratio = Short Term Debt + Long Term Debt / Total Shareholders Equity Changes in Equity, Fixed Assets & Long Term Debt.

Activity 2

Building financial backgrounds

Account Turnover. Monthly Transactions. Tax Returns.

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