Fina 465 - Commercial Banking - Lending
Terms in this set (27)
Evaluate a borrower's ability and willingness to repay
Questions to ask
- What risks are inherent in the operations of the business?
- What have managers done or failed to do in mitigating those risks?
- How can a lender structure and control its own risks in supplying funds?
Five C's of Good Credit
Character: Borrower's credit
Capital: Where Money is going
Capacity: How much money is needed
Conditions: How and when debt will be paid back
Collateral: Evaluate collateral or the secondary source
Who makes loan decision?
- Individual officer
- Centralized underwriting
- Formalizes the purpose of the loan
- Terms of the loan
- Repayment schedule
- Collateral required
- Any loan covenants
- States what conditions bring about a default
Perfecting the Security Interest. (bank's claim is superior to that of other creditors and the borrower)
Loan Commitment/Line of Credit
Formal agreement between a bank and borrower to provide a fixed amount of credit for a specified period
The customer determines the timing of actual borrowing
Working Capital Requirements
Net working capital = Current assets - Current liabilities
For most firms, net working capital is positive, indicating that some current assets are not financed with current liabilities
Cash / (Sales/365)
AR / (Sales/365)
Inventory / (COGS/365)
AP / (Purchases/365)
Accruals / (Operating Expenses/365)
Cash / (Operating Expenses/365)
Cash-to-Cash Asset Cycle
How long the firm must finance operating cash, inventory and accounts receivables from the day of the first sale
Cash-to-Cash Liability Cycle
How long a firm obtains interest-free financing from suppliers in the form of accounts payable and accrued expenses to help finance the asset cycle
Character: What is the character of the borrower and quality of information provided?
Capital: What are the loan proceeds going to be used for?
Capacity: How much does the customer need to borrow?
Conditions: What is the primary source of repayment, and when will the loan be repaid?
Collateral: What is the secondary source of repayment; that is, what collateral, guarantees, or other cash inflows are available?
Figure out their character... use credit history, references...
Capital (Where money is going)
Use of Loan Proceeds: Loan proceeds should be used for legitimate business operating purposes, including seasonal and permanent working capital needs, the purchase of depreciable assets, physical plant expansion, acquisition of other firms, and extraordinary operating expenses.
Not: Speculative assets, debt substitutions, dividends...
Capacity (How much money)
Borrowers often request a loan before they clearly understand how much external financing is actually needed and how much is available internally.
The amount of credit required depends on the use of the proceeds and the availability of internal sources of funds
Determining how much is needed
Short term: Seasonal inventory to support spike in inventory. These are typically paid off through decreasing inventory (sales) or when a receivable is finally paid.
Long term (term): Projecting needs using proforma analysis. Term loans are typically repaid out of cash flows from operations, specifically earnings and noncash charges in excess of net working capital needs and capital expenditures needed to maintain the existing fixed asset base
Loans are repaid from cash flows
This will for sure be on the quiz...
The Primary Source and Timing of Repayment
Loans are repaid from cash flows
Loans are repaid from cash flows:
How those cashflows are generated:
- Liquidation of assets
- Cash flow from normal operations
- New debt issues
- New equity issues
Risk in Repayment
The primary source of repayment on the loan can also determine the risk of the loan
The general rule is not to rely on the acquired asset or underlying collateral as the primary source of repayment
Evaluating Credit Requests
1) Overview of management, operations, and the firm's industry
2) Common size and financial ratio analysis
3) Analysis of cash flow
4) Projections and analysis of the borrower's financial condition
ΔAssets = ΔLiability + ΔNet Worth
Cash Flow From Operations
- Δ non-cash asset
+ Δ new stock
+ Δ surplus
Δ in Cash ( I don't think we need to know all of this)
Uses of Cash
Decrease in any liability
Increase in a non-cash asset
Repayments/Buy back stock
Deductions from surplus