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

Commercial Credit Risk Analysis and Approval: Behind the Scenes January 21, 2016

Comerica Bank Presenters 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. 2

Agenda  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 3

The Current Bank Lending Environment 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 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 4

Holistic Approach to Evaluating Credit Risk Customer Level Risk Evaluation Treasury Management Credit and Loan Facilities: Products: Industry Business, Risk Risk of Operational and Repayment Credit Risk 5

Risk Inherent in Treasury Management Products  ACH (Automated Clearing House)  BDC / RDC (Remote Deposit Capture)  Commercial Card  Controlled Disbursement  Zero Balance Account 6

ACH Credit Risk 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) 7

Risk Inherent in Treasury Management Products – ACH 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 8

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 9

Risk Inherent with ACH Transactions – ACH Diagram ACH Operator(s) RDFI ODFI $ $ $ Originator Credit Receiver Debit 10

Risk Inherent in Treasury Management Products - RDC 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 11

Risk Inherent in Treasury Management Products 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 12

Roles and Responsibilities in the Credit Approval Process CUSTOMER Owner, CFO, Controller BANK Relationship Manager KEY ADVISORS Treasury Sales Officer CPA, Attorney, Consultant Credit Officer Loan Committee CREDIT APPROVAL 13

Financial Information Required to Assess Creditworthiness 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 14

Credit Underwriting Considerations Why do banks ask so many questions? THE FIVE Cs of CREDIT: CASH FLOW COLLATERAL CHARACTER CAPITAL CONDITIONS 15

Sources of Repayment Third Primary Secondary Repayment Repayment Repayment Source: Source: Source: Personal Cash Flow Collateral Guarantee 16

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 17

The Risk Rating Process 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 18

The Credit Approval Process and Loan Committee 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. 19

Working with your Financial Institution: Best Practices Do’s Don’ts Tell your story and tell it straight: good Spend the money before your loan is or bad 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 Create fire drills due to poor planning situations change Say “I’ve never missed a payment” Provide timely financial information Schedule regular reviews of TM Ignore signs of fraudulent activities services with your Bank Recognize the value proposition for Expect large, technical projects to be new services completed immediately Commit appropriate resources for new projects 20

Questions and Answers