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Bank Credit Officers Questions

- Who is customer, customers character, purpose of transaction, capacityof customer to repay (fund payment, logistics, likelihood, bank protection),projected return commensurate with risk, credit extension structuring

- Collateral enforces prior willingness to pay off loan- Loans that support normal business ops. (Capital loan) given priority overspeculative loans

Repayment sourcesa) Conversion of assets to cash (inventory etc.)b) On-going Business Earnings/CFs (in term loan, delivery van to sell goods)c) Injection of new capitald) Transfer of loan to other lender (takeout loan)- R/E Development: LTA financed by LT loans (commercial mtg. from Life

Ins. Co)

Repayment programs- Op. purposes or seasonal needs (salaries, A/R, inventories, raw materials- Revolve: outstanding balance fluctuates U/D at discretion of borrower

(sets ceiling)- Clean-up each year (decreases interest expense, use financial metrics

Evaluation of collateral- Value of collateral = f(type of collateral, ease of re-possessing, valuators

opinion, insurance)- Want to be in 1st position if need to call on collateral

- Personal guarantees: small business owners

Term: repayment schedule with frequent repayment dates- Balloon/Bullet: pay back almost entirely at maturity

Types of Credit Extensiona) Advance of funds: demand loan, term loan, substitute income debenture,

mortgage, leaseb) Advance of Commodities: loan of metal to mine, securities to Inv. Dealerc) LOC, guarantees, acceptancesd) Purchase/Sale/Exchange of funds or commodities (buyer/seller

relationship)e) Commitments to do:

a. Uncommitted linesb. Committed lines of creditc. Note issuance facilities (bank purchases, unmarketable short-term

notes)

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Structuring: follow naturally from customers request to meet needs; providedegree of safety and profitability required by bank

- 6 factors:o Amount (reflect real needs?)o Currency (appropriate? FX risk?)o

Pricing (reflect risk/term/policy?)o Term/Repayment (op. needs? Adequate CF?)o Collateral (security matched to type of credit)o Conditions (realistic, met now/future, satisfactory reporting

conditions)

Conditions: reporting requirements, freedom of customer/borrower to takeactions in business (disposal of assets/collateral or impairment), min/maxfinancial ratios, definition of default, definition of material adverse change, includecross-default clause

Bank Commercial and Corporate Lending

- Factoring: receivables are sold to a bank as a factor- Blanket lien: gives lender a general claim against inventory of borrow- Trust receipt lending (floor planning): claim on specified inventory items

Credit Decisions: minimize credit loss, but create the most value- Character: borrowers desire to repay the loan as promise- Capacity: amount of CF in relation to loan payments, stability- Collateral: assets that can be sold if customer defaults/collection fails

Common Conditions on Loans- Margins (based on levels of operating assets)- Net working capital (current ratio)- Debt ratio (limited to total assets or equity)- Dividends, repurchases- Salaries- Personal Guarantees

Five Principles to Find Best Lender for Your Company1. Know lenders business philosophy2. Make sure lender really wants to make the loan3. Make sure lender has adequate depth and capacity4. Look for a relationship, not just a transaction5. Consider all costs

Four Hurdles of Commercial Lending1. Is borrower honest? Moral obligation to fulfill contracts/pay debts2. How will loan proceeds be used? WC, fixed asset purchase,

speculative

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3. Source of repayment? CF< Asset sale, outside capital injection,borrowing elsewhere (interim construction loan)

4. Back-up Source of Repayment? Future positive CF backed up byreliable secondary sources

Structuring Business Plan Presentation for Bank Loan Application- Introductory Section > Description (History/Background, Management,Marketing, Financial Plan, Operational Data, Conclusion) > Appendices

The Credit Process- Application > Evaluation > Structuring > Authorization > Set-up/Advance>

Maintenance

Bank Loan Covenants

- Control potential credit-impairing activities

- Ensure unfavorable events subsequent to granting of loan do not goundetected by the bank

Positive Covenants: submit financials, A/R collection experience, periodiccertificates, maintain corp. existence, maintain insurance/costs, payroll taxes,inform bank of material adverse change

Negative Covenants: protect bank, but do not impair business ability to achievemission

1. CF Control (ICR, FBCR, CF-Debt, Min. Net Working Capital, CurrentRatio)

2. Strategy Control (capital exp., bond/stock investments, outside loans,M&A)

3. B/S Maintenance: current ratio, NWC minimum4. Asset Preservation: limit disposal of non-inventory assets or negative

pledge clause5. Loan repayment triggers: right to recall loan (credible threat), events of

default

Small Business/Knowledge-Based Firm Lending

Get Financing You Need- Summary (how much used, when repay) > Business (ownership/legal

structure) > Products/Patents/Sales > Size/Market Potential > Facilities >Proof of Sufficient CF > Capital Needed/Why

Build Strong Ties with Bank- Character > Capability/Experience/Invested Capital > State of Industry,

Coverage Available > CF/ability to repay > Amount of Collateral

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6 Challenges in High-Tech Lending:1) Collateral: less tangible assets (knowledge, people, networks)2) Obsolescence: must manage inventories well3) Reporting: more frequent, supply/orders/pricing on monthly basis4) Complexity: hire independent consultant

5) Receivables: without support for software, customers unwilling to honor6) Risk: loan losses no greater than other businesses, but must sell business