5 C's of Credit

1. Presented by:
Chuck Nwokocha
Senior Risk Management Consultant

2. Financial information company that provides credit
and risk management solutions to financial
institutions

Data and applications used by thousands of
financial institutions, corporations and accounting
firms across North America

Awards
Named to Inc. 500 list of fastest growing privately held
companies in the U.S.
Named to Deloitte’s Technology Fast 500

3. Chuck is a graduate of Harvard University, with a
B.A. in Psychology with a focus in Organizations
and Economics. He began his professional career
with Guardsmark, a private security services
company where he held various positions and
responsibilities – in operations, human resources,
and sales, and management. He has founded two
e-commerce sites, Ndekanyi.com – a social
networking site for the Igbo people and SwapU.com
– a college classifieds network. Additionally, he has
consulted on marketing, social media, and user-
generated content.

At Sageworks, Mr. Nwokocha is an expert credit &
risk management consultant helping financial
institutions manage their loan portfolio , focusing
on the Allowance for Loan and Lease Losses (ALLL),
Stress Testing, Credit Analysis, Risk Rating, , and
Loan Administration management. With subject-
matter expertise, he helps financial institutions
understand and comply with federal accounting
guidance.

Chuck Nwokocha
Senior Risk Management
Consultant

4. Enhancing Your Credit Quality
1.3 P’s: Policies, Process, People
2.5 C’s
a.5 C’s of Credit
b.5 C’s of Data Collection
c.Credit Risk Modeling
3.Considerations for Underwriting
a.Documentation for Underwriting
b.Considerations for Underwriting
c.Tools for Analysis
4.Lending Environment
a.Loan Portfolio Composition
b.Loan Growth by Loan Type
c.Survey Results
d.Emerging Trends
e.Important Ratios in C&I
5.Examinations
a.Examination concerns with C&I
6.Bankers’ Advice
4

5. Policies
Sound underwriting

Process
An efficient, balanced approval process

People
A competent lending staff

6. Certified mail
must be delivered
to X-person.
Mail/delivery requiring
signatures must be
signed by a VP
Outgoing mail to IRS
must be delivered with
a confirmation receipt
Provide the framework for the bank’s lending activities

Set the standards for portfolio composition, individual credit
decisions, fair lending, and compliance management

Supplemented by more detailed underwriting standards,
guidelines, and procedures
Refers to a particular way in which something is done

7. Refers to a way of doing something
 Establishes the lending process

Assigns accountability and establishes the responsibilities of
the people involved
Mail gets delivered
every day.
When the mail is
delivered, it is sorted.
The sorting is determined
by dept and purpose for
each piece

8. A competent lending staff
Refers to the individuals executing the process

9. Policy
Provide the framework for
the bank’s lending
activities. Sets the
underwriting standards for
the credit decisions
Process
Policy establishes the
lending process and
the responsibilities of
the people
People
The individuals
executing the
process Training
Knowledge/ skills
required to execute
the process and use a
procedure
Tools
The Tools used in
the execution of the
process
The lending staff, with the knowledge and skills, utilizing various tools, arrive at
quality loan decisions.

10. Capacity
Measures a borrower’s ability to repay a loan by comparing
income against recurring debts
Can the borrower generate adequate cash to repay the loan?
Capital
Refers to the net worth, or equity, of a business
Is the borrower adequately capitalized within industry standards
to withstand unexpected loss?
Conditions
The economic, industry, and market environment can and will
change; the state of the borrower or the state of the economy
Is the borrower flexible enough to adapt?

11. Collateral
Helps secure the debt.
Is there an alternative source of repayment in case the primary
source fails?
Character
Personal integrity of business owners and officers
Is management willing to repay the loan and will it attempt to do
so under adverse conditions?

12. Credit Risk

Determining risk factors

Understanding credit quality (risk grading/risk
rating)

Likelihood that a business/borrower/relationship
may default on its financial obligations

Model should account for different types of loans
as well as industries (diff industries require diff
capital structures)

13. A complete picture of the
financial condition of a
small business requires a
careful review of income
statement and balance
sheet information for
both the guarantor and
the business. Personal
assets are often pledged
against the debt of the
business, and business
and guarantor financial
assets occasionally are
intertwined.

Global Cash Flow Analysis

14. It’s common for owners to
lend personal funds to, or
borrow funds from, their
businesses.
It’s common for the business
(for tax advantages,
primarily) to rent its
office/warehouse/production
facilities from a real estate
holding company or
partnership controlled by the
business owners.
It’s common for owners to
control their own levels of
salaries, bonuses, benefits,
and dividends to the extent
allowed by prudence and tax
regulations.

15. Annual Reviews
Set a minimum review period that allows continual and
regular monitoring and reassessing of risk
The reviews will lead to early identification of deteriorating
conditions

Trend Analysis
Companies rarely remain in a static condition
Cash flow cannot be the only determinant
Credit analysis is much too complex to rely on just a single
indicator

16. 0
100
200
300
400
500
600
700
2007 2008 2009 2010 2011 2012
Growing Business
Deteriorating Business
A look at the trend is critical in determining if the business in growing or deteriorating.

17. Caliber
Refers to the quality of the financials provided. What types of
financials?
- Audits - Reviews - Compilations
- Tax Returns - Company prepared

Complete
Are all of the forms/ schedules present? Did the borrower provide
debt schedules?

Consistent
Are the financials consistent? Did the borrower provide
compilations one year and tax returns another year?

18. Current
Did the borrower provide the most recent financials?

Conversation
Conversations with the borrower(s) help to cover those
gaps in information as well as provide supplemental
explanation or lend additional insight

19. 1. Financial information – used to establish repayment capacity
A. Business financials
-Current and historical income data, balance sheet
-Balance sheet, income and cash flow projections
-Comparative industry data when appropriate
B. Guarantor financials
-Guarantor support and related financial information
-Summary of borrower and affiliated credit relationships

2. Collateral identification and valuation
-Collateral agreements and appraisals

20. 3. Loan structure information
Loan terms, including tenor and repayment structure
Pricing information, including relationship profitability data

4. Loan agreement
Covenants and requirements for future submission of financial data
Exceptions to policy and underwriting guidelines
Promissory notes, note guarantees

5. Supplemental Information
Information fields to capture data for concentration reporting, identifying
SNCs (Shared national credits) etc.
Risk rating or recommended risk rating

21. Understanding financial statements and the significance of
the ratios requires both skill and time

Translate financial numbers into meaningful assessments of
company’s financial performance

Tackle these complex sets of information, condense the
information into digestible chunks

Utilize software, such as the Sageworks Analyst solution

To input the information, to spread it into a consistent and
standard format, and generate an analysis of the ratios

Concentrate on the key aspects of liquidity, leverage, and
cash flow, using ratios, trends, and industry analysis to study
them

22. 22
Business(es)
Personal
Guarantor(s)
Real Estate
Global Cash Flow
Eliminate Double-Counting
Real Estate
Sageworks Analyst™
TruGlobal™ Credit Analysis
• Standardize cash flow analysis
• Improve accuracy

24. Sageworks Analyst™
TruGlobal™ Credit Analysis
• Standardize cash flow analysis
• Improve accuracy

25. Sageworks Analyst™
TruGlobal™ Credit Analysis
• Standardize cash flow analysis
• Improve accuracy

26. Sageworks Analyst™
TruGlobal™ Credit Analysis
• Standardize cash flow analysis
• Improve accuracy

27. Sageworks Analyst™
TruGlobal™ Credit Analysis
• Standardize cash flow analysis
• Improve accuracy

Combines multiple businesses,
people and properties to view global
cash flow and debt service numbers
Eliminates double-counting
Accurately
assesses impact
to Debt Service
Coverage Ratio

29. C&I loan competition intense and increasing
C&I and loan underwriting standards easing
Net easing for 8 consecutive quarters.
CRE lending standards easing, but credit supply
relatively tightened in 2012
C&I loan rate spreads decreasing
60% of bankers surveyed report ↓ spreads for loans to larger
businesses.
46% of bankers surveyed report ↓ spreads for loans to small
businesses.
Regulatory authorities increasing exam scrutiny of
C&I lending practices

32. Source: Federal Reserve Board “Senior Loan Officer Opinion Survey on Bank Lending Practices,” May 2013.

33. Longer terms with lower payments
15, 20, 25, & 30 Year Amortizations
3, 5, 10, 15 Year Fixed Rates

Fully amortizing; no balloons or calls

Preference for Owner-Occupied Properties or
Investor Properties

Full collateral coverage not required
Preference for up to 75% Loan to Value (LTV)

Minimum 1.25 DSCR

Personal Guarantees
Full and unlimited personal guarantees from all owners of 20%+

34. Key Drivers of cash flow
Sales (Revenue Growth)
Gross Margin
Accounts Receivables
Accounts Payables
Inventory Days
S, G & A (Selling, General, & Administrative Costs) – better
known as overhead.
Capital Expenditure

35. Liquidity ratios
Current ratio
Quick ratio
Working capital


Leverage ratios
Debt service coverage
Interest coverage ratio
Debt to Equity Ratio


 Efficiency ratios
Accounts Receivables days
Accounts Payables days
Inventory days


Profitability ratio
Gross Profit and Gross Profit Margin

36. Inexperience with business entities
Financial data: what to collect, when
Industry specifications: what is normal for a particular industry
Global cash flow analysis methodology
Move from collateral to cash flow analysis
Avoid double-counting, while recognizing intermingled income
and debt
Inadequate strategic planning
Policies & procedures account for C&I
New risk appetites

37. 1.Re-evaluate concentration limits and risk appetite
2.Review Underwriting Policies
3.Train personnel, the board
4.Invest in technologies
5.Hire appropriately
6.Look outside the institution (potentially)

38. Asset quality is a huge area of focus by examiners

Main criticism areas included:
Risk rating systems
Higher rates of delinquent and non-performing loans
Loan reviews that weren’t completed annually or were inconsistent
Quality issues related to the financial institution’s growing pains,
the overall economy or continued real estate devaluation

39. Many comments relate to documentation of loan
files, tracking information and global cash flow
analyses:
“Document everything, even if you think it’s trivial.”
“Make sure all info is current.”
“Be on top of flood insurance and exceptions.”
“Document EVERYTHING.”
“Calculate twice, print once.”
“Focus on global cash flow and asset verification.”
“Policies should be written and followed.”

40. Bankers mentioned thorough documentation as a
benefit. Among some other pieces:
“Our exam did have some former OTS examiners, and there was
definitely a different approach taken by them. The lead reviewer
had to focus them on the areas that really needed evaluated. They
were picking on things in the file that were five years or older that
were irrelevant to the credit risk today.”

“Need to remain patient and carefully explain Bank’s position.
Prudently point out differences of opinions. Ask for clarification of
criticisms.”

“Dinged for little things; need more documentation; did not like
missing documents in loan files; better analysis.”

41. Presenter Contact Information:

Chuck Nwokocha, Sageworks
[phone] ext. 637
[email protected]
www.sageworksanalyst.com

Next Webinar:

Loan Workout 101 for Financial Institutions
Thursday, September 12, 2:00 PM EDT
http://web.sageworks.com/loan-workout-cooley/