Commercial Credit Risk Analysis and Approval: Behind the Scenes - - PowerPoint PPT Presentation

Commercial Credit Risk Analysis and Approval: Behind the Scenes

January 21, 2016

Joyce Conley, CTP, Vice President, Treasury Management Sales

Joyce joined Comerica Bank in 2012 as part of the Treasury Management Sales team. She has been in the banking industry for over 25 years, of which 15 were in Treasury Management. She is responsible for a customer portfolio, including Middle Market banking, Large Corporate, Technology and Life Sciences and Equity Funds Services. She received her undergraduate degree in Industrial/Organizational Psychology from Loyola University, Chicago, IL. She is a Certified Treasury Professional (CTP) and an active member in the Detroit Treasury Management Association (DTMA).

Kimberly Reich, Vice President, Treasury Management

Kim joined Comerica Bank in 1989 as part of the credit analyst training program. She has held lending positions as a Relationship Manager in Comerica’s Healthcare, Higher Education and Municipal Lending Group (1991-2000) and Middle Market Banking (2000-2015). In October 2015, she joined Comerica’s Treasury Management Group focusing on Product, Sales, Risk and Onboarding initiatives that impact the Customer Experience. Education includes an undergraduate Degree in Finance and Economics from Central Michigan University,

• Mt. Pleasant, MI, and a Master of Science-Finance Degree from Walsh College, Troy, MI.

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Comerica Bank Presenters

• The Current Bank Lending Environment
• Holistic Approach to Evaluating Product Risk
• Risk Inherent in Treasury Management Products
• Roles and Responsibilities in the Credit Approval Process
• Financial Information Required to Assess Credit Worthiness
• Credit Underwriting Considerations
• The Risk Rating Process
• The Credit Approval Process and Loan Committee
• Do’s and Don’ts of Working with your Banker
• Questions and Answers

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Agenda

Credit Availability

• “It has been said that a banker is someone who lends you an umbrella

when the sun is shining and takes it away when it starts to rain”

• 2008 vs. 2015
• Historically low rates, competition and strong bank liquidity driving credit

availability

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The Current Bank Lending Environment

Effects of the December 16, 2015 Fed Rate Hike

• Fed raises the Fed Funds rate for first time in nearly

seven years

• Floating rate loans, interest rate hedging
• Impact on bank liquidity and depository balances

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Holistic Approach to Evaluating Credit Risk

Customer Level Risk Evaluation

Credit and Loan Facilities: Risk of Repayment Treasury Management Products: Business, Operational and Credit Risk Industry Risk

• ACH (Automated Clearing House)
• BDC / RDC (Remote Deposit Capture)
• Commercial Card
• Controlled Disbursement
• Zero Balance Account

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Risk Inherent in Treasury Management Products

Credit Entries:

• Time (temporal risk) – two day credit window
• Funding method (internal, check, wire, ACH, etc.)
• Credit quality of customer
• Value of batch file
• Outsourcing to a Third Party

Debit Entries:

• Time
• Exception entries (returns)
• Credit quality
• Value of batch / file
• Value of collateral (if any)

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ACH Credit Risk

Operational – The risk that a human error or computer mishap may delay or alter an ACH transaction.

• Hardware / Software / Power failure
• Telecommunication failure
• Human error
• Staffing problems, issues
• Disaster

Fraud – The risk that dishonest or criminal attempts may be made to misappropriate funds.

• Fraudulent file, batch, or entry
• Alteration of company file, batch, or entry

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Risk Inherent in Treasury Management Products – ACH

Credit Products:

• Direct Deposit - Payroll
• Corporate Cash Concentration
• Business to Business Payments

Debit Products:

• Direct Payment
• Cash Concentration
• Consumer Payments
• Business to Business Payments

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Risk Inherent in Treasury Management Products - ACH

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Risk Inherent with ACH Transactions – ACH Diagram

ODFI ACH Operator(s) RDFI Originator $ $ $ Credit Debit Receiver

Remote Deposit Capture (RDC)

• Fraud
• Alteration of deposited items / forged endorsement
• Redeposit of items / duplicate presentment
• Deposit of counterfeit items
• Poor image quality
• Safety and integrity of deposited items held by customer (protection of

personal information)

• Proper disposal of deposited items

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Risk Inherent in Treasury Management Products - RDC

Commercial Card

• Timing of Payment
• Employee fraud
• Purchasing policy compliance (misuse)
• Company credit limit, late payment or average transaction size penalties

Controlled Disbursement

• Early presentment of checks
• Funding the account

Zero Balance Account

• Insufficient collected balances
• Intraday exposure

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Risk Inherent in Treasury Management Products

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Roles and Responsibilities in the Credit Approval Process

CREDIT APPROVAL BANK Relationship Manager Treasury Sales Officer Credit Officer Loan Committee CUSTOMER Owner, CFO, Controller KEY ADVISORS CPA, Attorney, Consultant

Banks use the following information to assess a Borrower’s creditworthiness:

• CPA prepared financial statements
• Company prepared interim financial statement for the recent quarter ended with

prior period comparable

• Balance Sheet and Income Statement projections
• Capital budget and maintenance capital expenditures
• Accounts Receivable and Accounts Payable Agings
• Sources and uses of funds
• Financial due diligence re: acquisitions
• Organizational chart
• Personal financial statement of owner
• Account structure and identification of treasury products involving risk – establish

appropriate ACH and Commercial Card limits

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Financial Information Required to Assess Creditworthiness

THE FIVE Cs of CREDIT:

CASH FLOW COLLATERAL CHARACTER CAPITAL CONDITIONS

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Credit Underwriting Considerations

Why do banks ask so many questions?

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Sources of Repayment

Primary Repayment Source: Cash Flow Secondary Repayment Source: Collateral Third Repayment Source: Personal Guarantee

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Mitigating Credit Risk: Example XYZ Company

Credit Strengths

1. Proven business model evidenced by historical cash flow more than sufficient to cover proforma debt service 2. Management character and integrity; willingness to support company during difficult times 3. Diversified sales mix drives stable historical gross margins 4. Revenue and profitability growth projected validated by contracts and POs in hand

Credit Weaknesses Mitigators

• 1. Balance sheet leverage High

Leverage to reduce with strong projected profitability Leverage covenant will enforce step-downs

• 2. Under-collateralized

Additional support in form of XYZ owner personal guaranty Owner proved willingness to inject cash equity during tough times

Components of Risk Rating Models

• Cash Flow – Can this Borrower adequately service the debt with a cushion?
• Balance Sheet and Leverage – Has this Borrower retained earnings and built equity

to withstand further economic downturns?

• Industry Considerations – What are the conditions in which the Borrower operates?
• Management: Character and Integrity – How has Borrower responded to crisis

situations?

• Collateral – If necessary and in the absence of Cash Flow, can collateral be

monetized to repay the debt?

Risk vs. Return Bank Capital and Regulatory Implications

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The Risk Rating Process

Relationship Manager working with Credit Analyst and Credit Officer compiles the Credit Approval Package which summarizes the following:

• Relationship history and update: Where we have been and where we are now
• Management and organizational structure
• Borrower line of business and industry analysis
• Historical Borrower financial trend analysis
• Historical and proforma cash flow analysis
• Borrower financial analysis write-up
• Industry and competitive analysis
• Economics of the overall banking relationship

Relationship Manager responsible for obtaining credit approval with the final level of credit approval dependent upon Risk Rating and Total Borrower Credit Exposure.

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The Credit Approval Process and Loan Committee

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Working with your Financial Institution: Best Practices

Do’s Don’ts

Tell your story and tell it straight: good

• r bad

Spend the money before your loan is approved Be prepared: have a plan Ever surprise your banker Ask questions if you do not understand Overpromise financial results Keep your banker informed as situations change Create fire drills due to poor planning Provide timely financial information Say “I’ve never missed a payment” Schedule regular reviews of TM services with your Bank Ignore signs of fraudulent activities Recognize the value proposition for new services Expect large, technical projects to be completed immediately Commit appropriate resources for new projects

Questions and Answers