Published on March 13, 2014
Lending: FromA Banker’s ViewpointLending: FromA Banker’s Viewpoint Presented by: Jamila Braithwaite
2 Sources of Repayment
3 5 C’s of Credit CharacterCharacter • Is the collateral sufficient as a tertiary source of repayment? If the collateral must be liquidated, is the realizable value enough to repay principal, outstanding interest and cover the bank’s administrative costs of liquidation? • What are economic and market conditions that could impair the company’s ability to service the debt and repay the loan? Does the company recognize these risks and have plans to mitigate them? • Does the borrower demonstrate a commitment to honor his or her transactions and keep promises even under adverse circumstances? CapacityCapacity ConditionsConditions CapitalCapital CollateralCollateral • Does the business demonstrate the capacity to apply the loan funds? Does management have a business plan? Are plant and equipment sufficient? Are marketing and product delivery well developed? • Does the company have sufficient net worth to absorb normal business risk?
4 The Loan Application • Ensure that the loan application is complete and accurate • Core bank loan application information often includes: o Historical business financial information (2 years) o Business and owner’s personal tax returns (2 Years) o Personal Financial Statement o Interim financial statements of the business and its owner for the current & prior year, along with accounts receivable and payable aging reports • Alternative (micro) loan application is similar, but often allows some flexibility – ask questions!
5 Underwriting Pillars • A company’s financial condition determines the borrower’s ability to generate enough cash to repay the debt • Three items in particular are evaluated: • Cash Flow • Liquidity • Leverage Financial Condition • It is necessary to determine the competence and integrity of key individuals running a company • A weak management team not only endangers the second source of repayment, but opens the doors for additional problems Management Quality • The bank will determine the realistic level of control over any collateral pledged, including its likely liquidation value or net present value • Inability to realize or “call” collateral threatens the third source of repayment Collateral / Security • Analysis of the industry focuses on the particular industry of the borrower and the borrower’s position within the industry • Weaknesses in the industry foundation can negatively impact a borrowers ability to repay Industry Dynamics
6 Underwriting Pillar– Financial Conditions Financial Conditions Profitability Liquidity Leverage • Indicates operating success, growth potential, and competitive position • Determines the company’s ability to meet obligations – Cash – operating expenses – debt service – supplies – credit • Determines the degree of financial risk and ability to absorb business risk • Sign of the owner’s commitment to the business as excess leverage is often a key cause of failing businesses
7 Important to Remember • Cash flow • Determine trends (revenue/expense) • Industry comparison (profitability, leverage, etc) • Owner’s salaries / bonuses / dividend payments Underwriting Pillar– DeeperDive on Financial Condition Profitability & Cash Flow Provides a better understanding as to how much excess income the company will generate and the factors that influence income EBIDA Debt Service Coverage (EDSC) Calculation: (Net income + interest expense + depreciation + amortization) / (Current portion long term debt (prior period) + Interest Expenses)
8 Liquidity The ability to quickly convert the company’s assets into cash Important to Remember • Evaluate integrity of creditor support (adequate asset protection for liabilities) • Evaluate current asset quality and aging of receivables (A/R > 90) • Assess shareholder’s support, willingness to guarantee / inject additional capital Underwriting Pillar– DeeperDive on Financial Condition
9 Important to Remember: • Evaluate capital • Assess creditor / shareholder support • 1:1 is good • 3:1 is guideline • Have to consider officer loans (to & from) and intangibles • Negative impact of treasury stock • Consolidating statements and evaluate receivables and payables to related companies Underwriting Pillar– DeeperDive on Financial Condition Leverage Comparison of borrowed capital to owner’s investment to determine risk of lenders if the company fails Leverage Calculation: (Total liabilities – Subordinated debt) / (Equity + Subordinated debt)
Underwriting Pillar– Industry Dynamics Industry Dynamics Restricted High Risk Desired • Adult • Casinos • Check Cashers • Speculative • Lenders • Start-ups • Restaurants • Contractors • Firearms • Pawn Shops • Professional • Manufacturing • Wholesale • Service
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