GENERAL INFORMATION

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GENERAL INFORMATION

• MICHAEL P. WILLACY
• VICE PRESIDENT-CREDIT CORPORATE BANKING.
• OFFICE929-3383
• FIRST GLOBAL BANK LIMITED
• ASSISTANT- CORNELLA ALLADICE
• E-MAILmichael.willacy_at_gkco.com

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General Lending principles

• A lender does lend money and does not give it
  away.
• Lenders must seek to arrive at an objective
  decision.
• The approach of the true professional is to
  resist outside pressures and to insist on
  sufficient time and information to understand and
  evaluate the proposition.

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Professional lending principles

• Take time to reach a decision-detailed financial
  information takes time to absorb. If possible, it
  is preferable to get the paperwork before the
  interview, so that it can be assessed and any
  queries identified.
• Do not be too proud to ask for a second
  opinion-some of the smallest lending decisions
  can be the hardest.

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Professional lending principles

• Get full information from the customer and not
  make unnecessary assumptions or fill in missing
  details.
• Do not take a customers statements at face value
  and ask for evidence that will provide
  independent corroboration.
• Distinguish between facts, estimates and opinions
  when forming a judgement.
• Think again when the gut reaction suggests
  caution,even though the factual assessment looks
  satisfactory.

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TRADITIONAL METHODS OF CREDIT ANALYSIS

• Anyone can lend, but lending money and ensuring
  it repayment distinguishes between a good banker
  and a bad banker. When you are dealing with
  people, it is almost impossible to predict how
  someone will behave in the future. It is
  important therefore that lenders exercise sound
  judgement while granting loan.

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Cond

• Lending principles help a banker to make sound
  judgement. Note however that principles are not
  laws of physical science that must hold whatever
  be the case rather, the principles serve as a
  framework within which to make a decision. This
  is why lending is more akin to art than to
  science.

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Cond..

• The purpose of any credit assessment or analysis
  is the measurement of credit risk. Borrowers
  credit assessment is done using the following
  criteria, popularly known as the five Cs of
  lending.

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FIVE Cs of Lending

• Character
• Capacity
• Capital
• Collateral
• Conditions

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CHARACTER

• Character is the sum total of human qualities of
  honesty,integrity,morality and so on.
• Character is perhaps the most important and at
  time the most difficult criterion to assess.
• Character assessment involves collecting
  information about the borrowers track record of
  integrity, repayment ability and spending habits.

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Means of gathering information

• Credit check of internal bank records or other
  financial institution.
• Contact of applicants employers and seek
  confidential information about the employee
• Documentary evidence such as salary statements,
  drivers license, utility bill
• Confidential reports from credit rating agencies
  are another source.

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Character assessment in relation to business
borrowers

• For business borrowers, character assessment
  involves assessing the character of the business
  owners or, in the case of companies, the members
  of the board.

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CAPACITY

• Capacity is the ability to repay the loan
  together with interest as per the pre-determined
  schedule.
• A borrowers capacity depends on two factors
  first, the borrowers financial position should
  be sound and second, the borrower must be able
  to generate sufficient net income to service the
  loan repayment.

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Cond..

• To assess whether the borrowers financial
  position is sound, lenders, in the case of
  personal loans often examine details of assets
  and liabilities. Also borrowers are required to
  give details of income and expenditure, and the
  net surplus available for repayment.

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Cond..

• In the case of businesses, lenders usually ask
  for audited financial statements and projected
  cashflow to determine the financial soundness or
  creditworthiness of the business borrower.

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CAPACITY

• Capacity is about the primary source from which
  repayment is expected to take place. It is
  important to assess the primary source from the
  outset

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CAPITAL

• Capital refers to the capital contribution that
  the borrower proposes to make in the total
  investment. An investment is usually financed
  partly by bank loan and partly by the capital
  contribution of the owner. The owners
  contribution is called the owners margin. The
  greater the owners contribution to a project the
  greater is the lenders confidence in the venture.
  Banks usually expect at least a 20 percent input
  from the borrower.

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COLLATERAL

• Collateral is also known as secondary source of
  repayment. When a loan cannot be paid out of
  primary source, lenders usually take possession
  of collateral and dispose of it and use the
  proceeds to set off the outstanding loan amount.

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QUALITIES OF GOOD SECURITY

• The price of the security should be stable, or
  not subject to wide fluctuations.
• The marketability of the security should be rated
  good.
• The security should be easily valued.
• The security should not deteriorate rapidly over
  time.
• If security is quickly transportable or portable,
  then the lender can sell it in another market.
  If the security is not portable then, the lender
  may find it hard to sell that security in the
  local market.

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COLLATERAL

• It is hard to find a security that possesses all
  the above qualities, and a lender is often
  required to judge an acceptable compromise. Land
  for example, may have stable value over time but
  it lacks the quality of portability.

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CONDITION

• An analysis of conditions covers external and
  internal factors. In my view it also covers the
  conditions and terms of the loan. The riskier
  the advance the stricter are the terms and
  conditions.

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EXTERNAL CONDITIONS

• Economy
• Industry
• Threat of war
• Political instability
• Crime

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Cannons of good lendingC.a.m.p.a.r.i

• Character
• Ability
• Margin
• Purpose
• Amount
• Repayment
• Insurance( security)

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INTERNAL CONDITIONS

• Lending policies
• Lending budget
• Availability of expert staff to monitor loan.
• A financial institution may decide to follow
  restrictive lending policies, the lending budget
  and the availability of a funds constraint, or
  to expand lending business in particular segments
  of the market. Credit analysis should take such
  aspects into account.

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Character

• It is virtually impossible to assess an
  individuals character just after one meeting. It
  is an extremely difficult area but vital to get
  right.
• How reliable is the customers word as regards
  the details of the proposition and the promise
  repayment.
• Does the customer make exaggerated claims that
  are far too optimistic.
• If the customer is new,why are we being
  approached? Can bank statements be seen to assess
  the conduct of the account.

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Ability

• This aspect relates to the borrowers ability in
  managing financial affairs and is similar to
  character as far as personal customers are
  concerned.
• Is there a good spread of skill and experience
  among the management team in, for
  example,production,marketing and finance.
• Does the management team hold relevant
  professional qualifications?
• Are they committed to making the company
  successful?
• Where the finance is earmarked for a specific
  area of activity, do they have the necessary
  experience in that area.

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Margin

• Agreement should be reached at the outset with
  the borrower in respect of interest margin. The
  interest margin will be a reflection of the risk
  involved in the lending, while commission and
  other fees will be determined by the amount and
  complexity of the work involved.

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Purpose

• The lender will want to verify the purpose is
  acceptable.
• Customers sometimes overlook problems in their
  optimism and if the bank can bring a degree of
  realism to the proposition at the outset, it
  maybe more beneficial to the customer than
  agreeing to the requested advance.

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Amount

• Is the customer asking for either too much or too
  little?.
• There are dangers in both and it is important
  therefore to establish that the amount requested
  is correct and that all incidental expenses have
  been considered. The good borrower will have
  allowed for contingencies.

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Repayment

• The real risk in lending is to be found in the
  assessment of the repayment proposals. It is
  important that the source of repayment is made
  quite clear at the outset and the lender must
  establish the degree of certainty that the
  promised funds will be received.
• Where the source of repayment is
  income/cashflow,the lender will need projections
  to ensure that there are surplus funds to cover
  repayment after meeting other commitments.

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Insurance/Security

• Ideally the canons of good lending should be
  satisfied irrespective of available security,but
  security is considered necessary in case the
  repayment proposals fail to materialise.
• It is important that no advance is made until
  security procedures have been completed,or are at
  least at a stage where completion can take place
  without the need to involve the borrower any
  further.

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EvaluationA two stage approach

• An assessment of the feasibility of the
  borrowers plan for repayment. If the proposal in
  not viable, it is pointless to continue.
• A critical appraisal of what might realistically
  go wrong-the likelihood of such events occurring
  and the effect on the banks position. The aim of
  this evaluation is to establish the risk
  involved. List the pros and cons of a proposition
  is often helpful. More reliance should be placed
  on facts and evidence than on estimates and
  opinions.

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Modern approaches to Credit risk measurement.

• The measurement and management of credit risk
  have undergone a revolution in recent years. The
  advances in technology have enabled financial
  engineers to try new methods of model building
  and analysis for credit risk measurement. Several
  factors have contributed to this recent surge in
  technology-based analysis methods.

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Cond..

• Increased competition in the loan market
  necessitated the development of methods that are
  quicker more accurate and more cost effective.
  Consumer expectations have increased and most
  consumers now expect efficient loan approval from
  financial institutions. Where lending
  institutions have been found to be a bit tardy,
  consumers have shifted to other institutions.

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Cond..

• Loyalty is less and less evident among consumers.
  Banks now need methods of credit assessment that
  cater to the changed customer needs. Also in
  recent years, bankruptcies and global competition
  have increased, so accurate credit analysis has
  become more important. The traditional system
  was based on expert knowledge only, requiring
  expensive and extensive staff training.

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Cond..

• Further, there was no guarantee that such trained
  staff would remain with the institution for long,
  and skilled staff often demand high salaries,
  which push up the fixed cost of making loans.
  The aim thus was to reduce lending institutions
  dependency on expert staff and reduce costs by
  applying technology solutions. Modern approaches
  help to achieve this aim.

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Cond..

• The more commonly used modern approaches to
  credit analysis include the following
• Econometric techniques involved in modeling of
  the probability of default.
• This probability is used as a dependent variable
  (effect) whose variance is explained by a set of
  independent variables (cause). Financial ratios
  and other external variables are generally used
  as independent variables. Econometric techniques
  include linear and multiple discriminant
  analysis, multiple regression, logit analysis and
  probit analysis.

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Cond..

• Optimisation models use mathematical programming
  techniques to minimize lender error and thus
  maximise profits.
• Neural networks try to emulate the human
  decision-making process using data as used in
  econometric techniques.
• Hybrid systems involve establishing causal
  relationships by estimating the parameters of
  such relationships. The KMV Corporations KMV
  model is and example of a hybrid system.