Day 1MODULE ONE:
Review of fundamentals of credit risk management and identifying troubled loans
Describes developments in credit analysis that fosters credit culture by helping banks to better manage their portfolios, assist with acquisitions to ensure that they are accomplished smoothly, and establish a common approach to profitable delivery of credit to the marketplace. Lenders who survive and prosper today will most likely be those who get assistance from sophisticated credit tools designed to help price loans and manage risk effectively.
• The prism credit model
• Management and administration
• Business operations & bank relationship
• Loan purpose and repayment
• Protecting the loan: setting up a matrix system
• Perspective
CASE STUDY: Crochet Candy Corp.
(NOTE: This case will be distributed to delegates as pre-course
reading and preparation in outline form as the basis for discussion)
The bank has been approached by Crochet Candy Corporation to provide a $500,000 increase to $2,000,000 in the existing unsecured line of credit. In light of attractive compensating balances and a relationship dating from 1968, the company has requested that pricing on the line be maintained at the Prime Rate. Delegates have the fiscal audited statements for review and must make a credit decision reinforcing the PRISM Credit Model.
MODULE TWO:
Ratio for credit analysis (multivariate ratio analysis)
Ratios provide the tools with which to measure the size, trend and quality of financial statements, and the extent and nature of liabilities. Delegates learn how to track historical performance, evaluate a firm’s present position, and develop ratio values to compare with industry averages. Does the borrower earn a fair return? Can it withstand downturns? Does it have the financial flexibility to attract additional creditors and investors? Is management adroit in its efforts to upgrade weak operations, reinforce strong ones, pursue profitable opportunities, and push the value of common stock to the highest possible levels?
• Ratio analysis
• Corporate finance issues
• Using quantitative benchmarks to improve ratio performance
• Fiscal year analysis
CASE STUDY: Oscar Products Delegates illustrate the use of financial ratios, and other analytical techniques for the evaluation of a firm’s existing and potential financial positions. The case, focusing on a lending situation, will also involve topics of (introduction to) forecasting, and the use of proforma techniques on specific ratios to understand how poor asset management policies affect cash flow.
MODULE THREE:
Cash flow workshop
This session starts by championing cash flow, one of the most powerful analytical tools in credit. Cash flow raises questions dealing with ways firms generate and absorb cash, with unresolved, serious issues forming the basis of a discussion with management. In order for delegates to understand the connection between cash flow and credit analysis, the module stresses that there is no substitute for understanding a firm and its management; the cash flow statement is a document, and its signals can only be detected by a prudent creditor fully involved with the company.
• What are sources and uses of cash?
• Developing a bankers cash flow statement
• Reconciliation how to spot “funny money”
• Check lists that insure reliability of your cash flow analysis
• Cash flow analysis of projects and joint ventures
• The art of merging cash flow and ratio analysis
CASE STUDY: Three Cash Flow Analysis
Day 2
MODULE ONE:Projections 1 – Introduction to modern projection analysis
Delegates start by exploring the different methods of predicting the borrower’s financial condition and identifying future funding needs. Everything in the future has a relative degree of risk and the greater the uncertainty, the higher the probability that projections will be inaccurate. Projections, therefore, are not intended to predict the future perfectly, but to see how the borrower will perform under a variety of situations. It is up to the lender to ascribe an expected probability to each set of projections and to determine a most likely scenario on which to base the credit decision. Projections quantify expectations and thus serve as an analytical tool in making credit decisions. Delegates review how research and well thought out assumptions create projections that are precise, detailed and offer useful insight into the future. The most modern forecasting tools are brought under study.
• Predicting bankruptcy using multiple regression forecasting methodology
• Learning to work with “e” and “f’ equations
• Sensitivity analysis vs. Simulation
• Adjusting critical assumptions and value drivers
• The projection write up
MODULE TWO:
Projections 2 – Monte Carlo simulation New tools in credit risk management and debt recoveries
Simulations are extremely valuable forecasting tools. Simulation models give decision makers and lenders the ability to answer questions dealing with budget constraints, profit planning and asset management decisions. Delegates are introduced to the technique known as “Monte Carlo” simulation. They work with an entire range of results and confidence levels feasible for any given situation. The principle behind Monte Carlo simulation comprises of real world situations involving elements of uncertainty too complex to be solved analytically. Stochastic Optimization procedures are used to identify optimal maximum or minimum values subject to constraints with simulation running in the background. Today’s Optimization models are robust, solving problems with thousands and even millions of variables without disproportionately tying up the bank’s computers.
• Defining assumptions
• Identifying a distribution type
• Defining forecasts
• Working with confidence levels
• Finding the certainty level for a specific value range
• Determining the expected default frequency
• Stochastic Optimization
• Use in debt recoveries
HARVARD CASE STUDY: Savannah West (Spreadsheet projections, simulation analysis of construction project, valuation and investment analysis, Expected Default
Frequencies) As vacancy rates began to drop in Savannah, Georgia, a local contractor saw an opportunity. The contractor realized the apartments market was growing rapidly. There had been little or multi-family construction in Savannah over seven years. As a result, vacancy rates in existing apartments were dropping rapidly. He took his plans and projections to Empire Bank who gave the builder a commitment on a take out basis providing covenants were not violated. Chemical bank was asked to provide construction financing. Delegates will evaluate the Chemical proposal using the computer and running different scenarios. The objective will be to determine the probability that the project’s operating cash flow will not cover debt service and (2) the probability that the project is undercapitalized. Teams will be formed: the loan committee and the lending group. The lending group will review the feasibility of the initial proposal and will recommend a more appropriate loan structure.
MODULE THREE:
The sustainable growth model: avoiding credit problems associated with lending to growing firms with high financial leverage
Growth is vital to the well being of a firm, but it is possible for a company to grow too quickly for its own good. This is particularly true among smaller companies
that are deficient in financial planning expertise. As a result, they do not fully comprehend that the faster they grow, the greater the need is for funds to support this growth. Increasing leverage can meet this need on a short-term basis, but eventually lenders will decline additional credit requests because debt capacity has been reached. With no cash available to pay its bills, bankruptcy could become a reality. All of this can be prevented if managers realize that growth above the firm’s sustainable rate creates financial problems that must be anticipated and solved.
• Prudent lending to thinly capitalized firms
• Using the model to analyze the underwriting IPO’s: debt
• Stabilizing growth via profit pruning
• How to set leverage tolerance levels
• Sales growth and financial leverage: finding an equilibrium
Day 3
MODULE ONE:
Credit rating grids for borrowers/facilities
Delegates learn to structure a credit rating grid and, in groups, undertake computer-modeling exercises with real data. Risk assessment and management are the key skills of a successful bank. The credit risk rating system gives a bank a common language and uniform framework for discussing and assessing risk. The system enables bankers to evaluate and track risk on individual transactions on a continuing basis. And most importantly, it enables banks to track and manage risk within the portfolio as a whole. Delegates will risk grade a borrower.
• The risk grading process
• Risk rating & loan portfolio optimization
• Ratings & expected default frequencies
• Standards & guidelines
• Borrower and transaction risks
• Evaluating and setting up obligor financial measure weights
• Evaluation collateral & guarantees
• Transfer and portfolio risk
• The auditing component of credit risk rating systems
CASE STUDY: A local African credit to be distributed in class
MODULE TWO:
Introduction to new techniques for predicting financial distress — secured and unsecured credits. Debt recoveries and managing turnarounds.
This module introduces the banker’s survival guide that explores the dynamics of troubled companies from the perspective of bankers providing methodology for success that is punctuated with real-world examples. A class discussion “Problem loans in Africa” concludes this module.
• Financial distress models
• Developing a check list of early storm signals
• Determining how troublesome loans may be candidates for classification
• Major sources and causes of problem credits
• How to value a turnaround
• Financial distress reorganizations
• Shareholder valuation: how this technique reveals expected default frequency of borrowers.
• Problem loans in Africa: “How do bankers identify problem loans before they happen?”
MODULE THREE:
Financial distress models and methodology
Can bankers detect signs early enough so that they can initiate a proper course of action before things get out of hand? Diagnostics serve the disease well so long as bankers take seriously the notion that to serve well is to learn well.
• A checklist of storm signals
• Financial distress models
• Problems in financial reporting
MODULE FOUR:
Loan workouts
The goals of workout are twofold: to explain why the credit is not performing as agreed and to develop an analytical foundation for thinking about solutions to the problem. Generally two choices are open to workout: loan restructuring or liquidation. We shall examine these alternatives more fully in the next section. For now, we assume a “goahead” mode aimed at loan restructuring so the concepts might be more succinctly developed
• Nature of Loan Workouts
• Loan classifications
• Follow-up procedures and documentation
• Lender liability
• Liquidation Vs. Restructuring Analysis
Day 4
MODULE ONE:
Analysis of problem seasonal loans
Most seasonal loans are unsecured; risks include inability to meet scheduled maturities, loss of principal and interest, and the possibility of conversion to “evergreen credit” that locks the bank into the credit for many years. Seasonal loans are self-liquidating and provide short-term working capital needs by financing seasonal increases in receivables and inventory. The liquidation or cash conversion / contraction process retires the loan at seasons end, which is one good reason banks actively seek seasonal loans. Seasonal firms typically finance seasonal working capital by purchasing raw materials on credit from suppliers, creating accounts payable and thus easing cash needs.
Basic analytics: break even inventory, cash budgets, financial analysis, the seasonal loan (credit file) write up.
MODULE TWO:
Jen krist case — analysis of a problem loan and debt recovery alternatives
Deal Analysis: Jen Krist Inc. “What went wrong?” Identify the storm signals in this middle market loan. Class discussion: could problems have been avoided? Delegates identify risks and evaluate the following alternatives: (1) we should liquidate our position i.e. the borrower is no longer viable; (2) we should see the company through a structuring i.e. the opportunity cost of liquidation is too high or (3) accept the status quo. Jen Krist Inc. is a mid sized clothing manufacturer and distributor. Founded in 1970 as children’s wear manufacturer, the firm expanded into designer apparel. Due to this unit’s poor sales performance and the severity of inventory write-downs, consolidated liquidity has been significantly eroded. Suppliers are steadily decreasing trade support, threatening to put purchases on a cash only basis. The firm now finds itself in a highly precarious financial situation.
This case builds on sequential credit and restructuring decisions as events trigger this apparel manufacturer’s rapid deterioration. Delegates work in groups and have to decide how far the bank group should go in supplying credit. A broad range of issues face the bank group a month after the fiscal books close. The bank meeting, with Money Centre Bank in a leadership role, must focus on the nature of the credit issues, the relationship between the bankers, and the broader contextual factors, and how these variables will influence the group’s decisions to either see the credit restructured or liquidated. Delegates must identify (1) major areas of weakness in this credit, (2) potential losses that the bank would incur if it does not continue to finance the company’s needs, (3) how covenants could be amended and the purpose of each covenant, (4) possibilities of a specialist (consultant) coming into the picture and (5) liquidation versus restructuring analysis.
MODULE THREE:
Debt recoveries and valuation (value engineering in turnarounds)
The module provides delegates with the financial tools and methodology to determine the value of a company when attempting a debt recovery and/or turnaround... Valuation is used to validate projections provided in a troubled borrower’s strategic plans.
• Comparing valuation methods: book value, last transaction approach (transaction sale), valuation multiples, liquidation valuation approach and cash flow approach
• Identifying the key value drivers
• The McKinsey valuation model
• Developing the cash flow valuation worksheet
• Using simulation to lock in more precise cost of capital and free cash flow results
• Techniques of organizing and writing up a borrower’s valuation appraisal