Topic 2 - Principles Of Lending Flashcards Preview

Term 8 - Credit & Lending > Topic 2 - Principles Of Lending > Flashcards

Flashcards in Topic 2 - Principles Of Lending Deck (28):
1

Key principles of lending

- profile of the customer - assess their character
- determine the lending criteria and purpose
- ability to repay - sufficient capital. Repayment profile consistent with cash flow projections
- suitable term
- security
- pricing to reflect the risk

2

Person -what 3 C’s should be considered?

Character
Capacity
Commitment / Capital - how much assets do they have?

3

CAMPARI

Character
Ability
Margin
Purpose
Amount
Repayment
Insurance - security

4

PARSERS

Person (3C’s)
Amount
Repayment
Security
Expenditure
Remuneration
Services

5

PARTS

Purpose
Amount
Repayment
Term
Security

6

5 C’s - the most important one!

Character - verify their identity; key characteristics - respectable; trustworthy; honest; dependable; high integrity.
Capacity - age (borrowing repaid before retire?); experience with this venture; reputation (for previous loans).
Commitment - skin in the game - higher contribution the greater the chances of our borrowing being repaid
Conditions
Collateral

7

Factors to consider to assess the character of an existing customer?

- how long have they been customer of the bank
- reputation and track record
- account handled in a satisfactory manner with previous borrowing repaid on time?
- regular lodgements on the account
- understand flows (min/max/average) over the last 3 yrs
- any charges applied re unauthorised overdrafts - evidence of item having returned unpaid for lack of funds?

8

Assessing character of a new customer

- previous bank and why did they leave?
- unhappy with service/high charges/ decline ?
- talk to people and meet the new customer at their premises

9

Profile of the customer - questions to consider

- financial acumen
- qualifications and experience
- age
- integrity and reliability
- organisational ability and efficiency

Do they understand their own business’s cost and capital structure

10

Character of the business - key issues to consider

- Capacity if the mgmt, business and industry
- how does the business compare with industry norms
- premises - owned vs leased? Terms of the lease? Does the business make enough to keep up with int payments? Sufficient space for business to expand? Next rent review?
- seasonality - retain profits
- management - relate well to each other? Identify with common goals and objectives? How is ownership and control distributed in the business
- plant and equipment -machinery owned or leased? How old and when does it need to be replaced?

11

Key issues to assess people and character

PESTLE - external - legal issues, industry and business sector, political issues, maker, economy, changes in taxation, competitors, technology and its impact on the product, supply chain.

Internal - cost structure, staff, succession planning, profitability, service levels.

12

Purpose of the loan - what to consider?

Is the purpose of the loan legal? Impact on reputation risk? Consider banks policy on lending to particular types of customer? Credit controls imposed by regulations? FCA’s guidelines - one customer cannot account for >10% capital base.

13

LTV

Loan to value - the ratio of the size of the borrrowing compared to the value of the asset being purchased; measure of risk for a lender. High LTV - high risk - high margin applied.

14

How does the term of the borrowing link to the purpose?

Depending on what the purpose of the loan will be, the repayment and term of the loan should be structured accordingly. The longer the borrowing term, the lower the monthly payments.

15

Commons reasons why the business borrows?

1) working capital - finance operating costs, variable costs, and fixed costs until trade debtors are converted into cash;
2) working capital - to finance stocks until they are converted to finished goods and sold and the debtors turn into cash;
3) long term debt with repayment from future cash flows - finance the purchase or refurb of PPE until used over many trading cycles in producing output which is converted to sales and then to cash;
4) growth -finance a whole range of asses and pay additional operating costs to support rapid growth;
5) Change in company’s ownership - e.g management buyout;
6) to finance one-off projects such as property development;
7) to finance survival - turnaround - to resolve cash leakage, insufficient profits or to recover losses. Risky!

16

Main stages of a trading cycle

Buys raw materials - starts producing goods - goods production complete - sell goods to consumers - collect cash from customers - use this to pay suppliers and expenses - buy new raw material again...

17

Why doesn’t increase in sale generate extra cash in all case?

- there is an optimum level where growth can be funded through profits
Therefore important to distinguish where customer is borrowing due to sales growth or due to slowdown in trading cycle.

18

Sources of repayment?

Refinance
Income - expenses (ensure this is a realistic projection and in line with other customers)

19

Typical items to use as security

- legal mortgages over property (standard securities in Scotland)
- floating charges from companies
- guarantees
- life policies
- stocks and shares

20

Covenants

Obligations on the borrower such as provision of info to the bank and adherence by the customer to financial covenants such as interest cover or gearing ratio. Ensures risk profile of the loans is maintain during its tenor.

21

What should a good business plan have?

- contact details
- synopsis
- business background
- products or services
- process
- market analysis
- marketing strategy
- proposal
- property
- management or staff
- financial information
- risk assessment
- PPE
- skin in the game

22

Loan suitable for an asset purchase

Term loans or asset finance product

23

3 factors to consider in relation to Security?

- simplicity of title - quick, cheap and easy to arrange, discharge - realise and release - e.g gov bonds
- stability of value - shouldn’t fluactuate too much. E.g quoted investments. Commercial property too hard to value.
- realisability - how quickly can the security turn into cash with minimal formalities as any delays can increase losses from the principal debt and interest.

24

How does a bank make money?

- net interest margin between lending and deposit rates
- loan arrangement fees
- charges for services provided by the bank
- commission and payments received from outside agencies for referring clients

25

Base rates

The general level of interest rates at which banks lend is mainly in line with the base rate set by the MPC of Bank of England

26

Factors which influence base rates

- level of price inflation in the economy
- unemployment
- actual and forecasted economic growth rate

27

Factors influencing lending rates

- terms m, income from fees, charges and commision, admin costs, rates offered by competitors for similar products

28

Portfolio management - after life of the loan facility

- monitoring loan covenants
- investigating irregular balances
- involving all members of staff to obtain an upto date relevant information on customer’s affairs
- undertaking visits to customer’s premises
- obtaining additional sources of info