Carl T. AbruquahMeridian Consults

The Chartered Institute of Bankers (Gh)

Agenda

Introduction Proposal Canons of Good lending Report Format Approval Term Sheet and Loan Agreement Disbursement Summary/Conclusion

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Introduction

Credit appraisal is a significant aspect of the credit management process.

If a loan will go bad, it should be established during the appraisal process so that any loss is prevented.

A weak appraisal system will lead to a deterioration in the Bank’s credit portfolio

Bank’s therefore provide standards for credit origination and appraisal

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Origination

The credit process commences when a customer submits a proposal or when a facility is due for renewal.

The Bank’s relationship arm may also initiate proposals.

Referrals are a useful source of fresh proposals.

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Credit Origination Units

The credit origination units are normally the business arms of the Bank.

These include: Corporate SME Retail – branches

Staff of these units have the duty of compiling all the requisite information about customer that is required to be submitted to the approving authorities

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Appraisal

There should be a structured system and format of appraisal.

Such a format will normally incorporate what has become established as the fundamental principles of good lending or canons of good lending.

Examples include CAMPARI and the five Cs.

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CAMPARI

Character Ability Margin or Means Purpose Amount Repayment Insurance

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Character

Trustworthiness Reliability Background and experience Track record Personal behavior

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Ability

Ability to manage financial affairs Skill and experience of management Balance of management skills Commitment of managements Experience in proposed area of

activity

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Margin

Pricing of facility Volume of work involved in

processing proposal Riskiness of proposal Margin above reference rate e.g

base rate

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Purpose

Acceptable Working capital or long term capital? Illegal Industry concentration risks. Bank policy.

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Amount

Should be sufficient for purpose If more or less than amount required

may result in waste or inability to undertake project.

Should match purpose Have all expenses been taken into

consideration? Customer contribution

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Repayment

Source of repayment should be made clear at the outset.

When source is cash flow from operations, should be supported by a cash flow forecast.

The Bank may have to develop its own cash flow in some circumstances.

The Bank should be satisfied that the funds generated will be sufficient to cover repayment of the facility.

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Insurance/Security

Appropriate Readily realizable Adequate Should serve as safety net and not

basis of approval of facility. Value should not be subject to wide

fluctuations and should not deteriorate rapidly over time.

Ease of valuation

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Report Format

Report should incorporate above principles.

Staff should be given training regarding preparation of report and issues to be raised in report.

There should be no political influence on the credit officer.

It is normally in a memorandum format with a heading indicating e.g. TO: CREDIT COMMITTEE FROM: SME NAME OF COMPANY: DATE

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Report Format

THE REQUEST Purpose, amount of credit, source of

repayment Background of borrower Credit assessment of the borrower’s

products, industry and macro economic factors.

Assessment of Management Profile Key success factors or SWOT analysis

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Report Format

Financials Historical Financial Analysis Analysis of forecast Analysis of repayment. Account Profitability

Account operations Track record/repayment history of

borrower. Overall risk assessment Summary and recommendations. PREPARED BY

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Areas of Appraisal

Business Risks Industry characteristics Competitive position of Product Management

Financial Risks Financial condition Profitability Capital structure Present and future cash flows

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Evaluation Business Risks Evaluation of Customer’s current

strategy Level of competition in the industry. Customer’s market share Position of product in life cycle Relative attractiveness of customer’s

product Qualification, age and experience of

management Balance of skills of management

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Financial Evaluation

Profitability Liquidity Activity Solvency Cash flow coverage Shareholder ratios

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Profitability

Return on Capital employed - defined as the ratio of operating profits (Net Profit before interest and taxes) to total capital employed. This is normally defined as shareholders funds plus long term loans

Return on equity – net profit after taxes divided by shareholders equity.

Gross Margin – defined as gross profit divided by sales

Operating Profit margin – operating profit divided by sales

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Liquidity

The cash cycle is calculated as the trade cycle plus credit taken and given cycles

The trade cycle is calculated as Raw material Inventory days in stock, plus Production cycle, Finished goods days in stock The time to pay creditors is subtracted The time for debtors to pay is added, giving The cash cycle.

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Liquidity

The Cash cycle ratios are Stock turnover – stocks in hand divided by

cost of goods sold times 365 days Creditors days – trade creditors divided by

purchases times 365 days Debtors days – trade debtors divided by sales

times 365 days. The liquidity ratios are

Current ratio - current assets divided by current liabilities

Quick ratio – current assets less stocks divided by current liabilities.

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Solvency/Coverage

Leverage or gearing is calculated as either prior charge capital divided by equity or prior charge capital divided by total capital (including long term loans)

Interest cover – net profit before interest and taxes divided by interest charges.

Debt ratio – total creditors (both long and short term) divided by Total Assets

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Stock Exchange Ratios

Dividend yield – dividend per share divided by market price of share.

EPS – net profit per share divided by total number of shares.

Earnings yield – earnings per share divided by market price per share.

Price earnings ratio – Market Price per share divided by earnings per share, reciprocal of EPS

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Financial Projections

Financial projections should be realistic in relation to current performance.

Most especially it should conform to industry growth rates and current level of sales.

What is the limiting factor? How will the company be affected by economic

conditions and cyclical trends? Has the effects of inflation been considered in drawing

up the estimates How will inflation and competition affect the pricing

policy? Does the budget reflect forecast demand of the

business and market at large? Above all the projections should confirm customer’s

ability to repay the facility

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Account Operation

Are sales receipts fairly regular and at a constant level or increasing level. Irregular receipts may arise from seasonality of business, cash transactions or diversion of funds into another account with another Bank.

Supplier payments should be fairly regular and of a constant or increasing level. Decreasing payments may arise from decreasing profitability or liquidity problems. Excessive increase may also arise from overtrading.

Round sum payments mean the business is paying on account and may be facing liquidity problems.

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Account Statistics

Average balances, lowest and highest balance Does the account swing into credit, or is a hard

core developing? Is the hard core increasing in size?

Is there a deterioration of the average balance? Largest debits and credits to the account Number of transactions per month and average

monthly number Excesses over anticipatory or agreed limits Dormant borrowing – perhaps customer has

abandoned the account and is operating with another Bank

How does the debit turnover compare with sales? Is the general pattern of the accounts changing?

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Approval

Approval levels Decision

Approval Decline Restructuring of proposal

Clear audit trail Arms length basis

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Term Sheet

The term sheet can serve as a basis of negotiation between the bank and the customer.

Once the borrower accepts the terms, they are considered as binding.

After the term sheet has been prepared, the two parties will negotiate in further detail and the loan agreement drafted.

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Clauses in Term Sheet

Facility Commitment Fee Purpose of Loan Availability Interest rate payable Maturity/term repayment of loan capital Early repayment of loan capital Broad details of security to be provided Conditions precedent

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Clauses in Term Sheet

Covenants Events of default Taxes Costs Confidentiality Assignment

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Areas of Negotiation

Price Structure Security and guarantees Covenants Provisions for transfers or

assignments

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Disbursement

An advance should only be disbursed after all documents have been executed and the necessary terms and conditions have been met.

Legal documentation e.g. relating to securities must be reviewed ideally by a specialized internal unit, before any loan or credit facility is disbursed.

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Summary/Conclusion

Banks should have in place structured procedures and formats for appraisal of customer proposals.

This would go a long way to minimize the significant risk involved in granting credit. Banks have established canons or principles of lending that should govern the granting of credit.

Any format for internal credit reports should incorporate these principles to ensure that a proposal is properly appraised and the right decision taken.

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THE END

THANK YOU36