Jamila Braithwaite from Capital One Bank gives entrepreneurs tips on how to access capital from banks at the Washington, DC Economic Partnership's Entrepreneur Road Map Business Financing seminar (3/12/14).
3. 3
5 C’s of Credit
CharacterCharacter
• Is the collateral sufficient as a tertiary source of repayment? If the
collateral must be liquidated, is the realizable value enough to repay
principal, outstanding interest and cover the bank’s administrative
costs of liquidation?
• What are economic and market conditions that could impair the
company’s ability to service the debt and repay the loan? Does the
company recognize these risks and have plans to mitigate them?
• Does the borrower demonstrate a commitment to honor his or her
transactions and keep promises even under adverse
circumstances?
CapacityCapacity
ConditionsConditions
CapitalCapital
CollateralCollateral
• Does the business demonstrate the capacity to apply the loan
funds? Does management have a business plan? Are plant and
equipment sufficient? Are marketing and product delivery well
developed?
• Does the company have sufficient net worth to absorb normal
business risk?
4. 4
The Loan Application
• Ensure that the loan application is complete and accurate
• Core bank loan application information often includes:
o Historical business financial information (2 years)
o Business and owner’s personal tax returns (2 Years)
o Personal Financial Statement
o Interim financial statements of the business and its owner for
the current & prior year, along with accounts receivable and
payable aging reports
• Alternative (micro) loan application is similar, but often allows
some flexibility – ask questions!
5. 5
Underwriting Pillars
• A company’s financial
condition determines
the borrower’s ability
to generate enough
cash to repay the debt
• Three items in
particular are
evaluated:
• Cash Flow
• Liquidity
• Leverage
Financial Condition
• It is necessary to
determine the
competence and
integrity of key
individuals running a
company
• A weak management
team not only
endangers the
second source of
repayment, but
opens the doors for
additional problems
Management
Quality
• The bank will
determine the realistic
level of control over
any collateral pledged,
including its likely
liquidation value or
net present value
• Inability to realize or
“call” collateral
threatens the third
source of repayment
Collateral /
Security
• Analysis of the
industry focuses on
the particular industry
of the borrower and
the borrower’s
position within the
industry
• Weaknesses in the
industry foundation
can negatively impact
a borrowers ability to
repay
Industry Dynamics
6. 6
Underwriting Pillar– Financial Conditions
Financial Conditions
Profitability Liquidity Leverage
• Indicates operating success, growth
potential, and competitive position
• Determines the company’s ability
to meet obligations
– Cash
– operating expenses
– debt service
– supplies
– credit
• Determines the degree of financial
risk and ability to absorb business
risk
• Sign of the owner’s commitment to
the business as excess leverage is
often a key cause of failing
businesses
7. 7
Important to
Remember
• Cash flow
• Determine trends
(revenue/expense)
• Industry comparison
(profitability, leverage,
etc)
• Owner’s salaries /
bonuses / dividend
payments
Underwriting Pillar– DeeperDive on Financial Condition
Profitability
&
Cash Flow
Provides a better
understanding as
to how much
excess income the
company will
generate and the
factors that
influence income
EBIDA Debt Service
Coverage (EDSC)
Calculation:
(Net income + interest expense +
depreciation + amortization) / (Current
portion long term debt (prior period) +
Interest Expenses)
8. 8
Liquidity
The ability to
quickly convert the
company’s assets
into cash
Important to
Remember
• Evaluate integrity of
creditor support
(adequate asset
protection for liabilities)
• Evaluate current asset
quality and aging of
receivables (A/R > 90)
• Assess shareholder’s
support, willingness to
guarantee / inject
additional capital
Underwriting Pillar– DeeperDive on Financial Condition
9. 9
Important to Remember:
• Evaluate capital
• Assess creditor / shareholder
support
• 1:1 is good
• 3:1 is guideline
• Have to consider officer loans
(to & from) and intangibles
• Negative impact of treasury
stock
• Consolidating statements and
evaluate receivables and
payables to related companies
Underwriting Pillar– DeeperDive on Financial Condition
Leverage
Comparison of
borrowed capital to
owner’s investment to
determine risk of
lenders if the company
fails
Leverage
Calculation:
(Total liabilities – Subordinated debt) / (Equity +
Subordinated debt)
10. Underwriting Pillar– Industry Dynamics
Industry Dynamics
Restricted High Risk Desired
• Adult
• Casinos
• Check Cashers
• Speculative
• Lenders
• Start-ups
• Restaurants
• Contractors
• Firearms
• Pawn Shops
• Professional
• Manufacturing
• Wholesale
• Service
Cash Flow from Operations.
This is the primary source of repayment. The question: is the company making enough money to repay its debts? must be answered satisfactorily to obtain approval.
Guarantor Support. This is the secondary source of repayment.
The questions: does the borrower have enough capital to support their business? And does the borrower have other sources of income to support the business? must be answered satisfactorily to obtain approval.
Collateral / Security. This is the tertiary source of repayment which the bank would look to in a worst case scenario.
The question: would the bank be able to liquidate enough collateral to cover its position? must also be answered satisfactorily to obtain approval.
The extent and nature of information needed for the loan application varies by loan type and amount
Often, 3 years of historical financial information is needed
Financial information of the owner(s) is needed for small businesses and those closely held by one or few shareholders
Also, open and candid discussion of a businesses challenges and risk is important for banks to better understand these issues and avoids surprises that can be damaging going forward
The information provided will be used to perform a thorough analysis of each of the following areas:
Cash reserves are very important
Ample liquidity demonstrates the ability to offset exposure.
Our internal loss experience has decreased dramatically when a business has 10M in checking.
Cash reserves are very important
Ample liquidity demonstrates the ability to offset exposure.
Our internal loss experience has decreased dramatically when a business has 10M in checking.
Cash reserves are very important
Ample liquidity demonstrates the ability to offset exposure.
Our internal loss experience has decreased dramatically when a business has 10M in checking.
Cash reserves are very important
Ample liquidity demonstrates the ability to offset exposure.
Our internal loss experience has decreased dramatically when a business has 10M in checking.
The type of industry in which a company operates within will have a significant impact in various areas of risk.
Industry Environment
Structural problems in an industry can affect overall risk of lending to an industry. Regulatory changes can have a negative impact on lending.
Company’s Position within the Industry
Competitive position is often heavily influenced by barriers to entry, bargaining power of suppliers and customers, and the threat of product substitution.
Industry Cycle