Credit Risk Practices for Business Banking III

Question 1

What ratings should be looked at in a financial risk assessment?

How should they be differentiated?

Answer 1

• Moderate and high risks
• They should be differntiated into:
  
  • Unlikely to happen
  • Likely to happen
  • V. likely to happen

Question 2

What ratios are used when assessing asset and liability risk?

Answer 2

• Sales growth %
• Gross margin % (GM%)
• Operating expenses %
• Net margin % (NM%)
• Stock days on hand
• Debtor days on hand
• Creditor days on hand
• Capital adequacy %
• Gearing %
• Interest cover times
• Cash cover %

Question 3

What items will a loan contract contain?

Answer 3

• The amount
• The cost of the borrowing
• Repayment terms
• Period of time covered by the agreement
• Conditions and convenants
• What the customer needs to do to prevent the facility being withdrawn (in the event of default)
• Security/collateral

Question 4

What’s the difference between lending convenants, conditions precedent and conditions subsequent?

Answer 4

• Conditions precedent - those items with which a customer must comply or provide prior to the drawdown of new/increased facilities e.g. satisfactory surveyors report, interest rate protection etc.
• ​​Conditions subsequent - after the drawdown which, once acheived, are regarded as closed.

Lending covenants are different as they are ongoing conditions of support.

Question 5

What are fees in a loan contract?

Answer 5

Fees will normally be x% of the facility being agreed, with min and max amounts

Question 6

What are interest rates in a loan contract?

Answer 6

Interest rates will be either x% over base rate or over the London Inter Bank Offered Rate (LIBOR). Each org has its own policy on what it requires to charge to meet its internal risk adjusted return on capital - the risk/reward ratio

Question 7

What should be in the Financial risk assessment?

Answer 7

The top 5 risks from business and market and note the liklihood of them occurring and how to mitigate.

Question 8

What is a financial statement?

Answer 8

It could be:

• Certified Accounts - containing
  
  • ​P&L account
  • BS
  • Notes to Accounts
• Audited Accounts
  
  • ​P&L acc
  • BS
  • Notes to Accounts
  • FRS1 Cash Flow
• Management Accounts
  
  • ​P&L
  • BS
  • Notes to Accounts
  • Cash flow - income and expenditure
  • Figures vs Projections
  • Aged lists of debtors/creditors

Question 9

What ratings can auditors give in their statement?

Answer 9

1. Unqualified - the certificate is issued without reservation (clean)
2. Qualified - the auditor has some reservations
3. Adverse - there’s possibly been a disagreement between the auditor and the client regarding the treatment of certain items in the P&L Account or BS
4. Disclaimer - the auditor hasn’t been given sufficient access to all the records

Question 10

What should the Documentation & Pricing Risk include

Answer 10

• Legal risk - standard business overdraft letter and a business term loan agreement
• Investment risk - service charge, interest rate and arrangement fee tariff
• Regulatory risk - details of commercial rating model and how the regulatory capital requirements are being handled by the bank

Question 11

What should be in the Credit Write Up/Credit Memorandum?

Answer 11

Basic info for the overdraft facility advice letter and the term loan agreement:

• How much
• How long
• Cost
• Security/collateral

It will not provide the rationale and reason why the credit facilities were granted.

Question 12

What risks are associated to Level of Environmental risk?

Answer 12

• Low risk - the business doesn’t produce harmful contaminants in its operations nor does it occupy a property that is situated on contaminated land
• Moderate risk - during the manufacturing or production processes, dangerous emissions are released into the factory resulting in contamination or are released into the atmosphere
• High risk - during the manufacturing or productions processes, contamination of both the factory and the environment is prevalent

Question 13

What risks are associated to Level of Environmental Compliance?

Answer 13

• Low risk - the business fully conforms to all environmental compliance criteria
• Moderate risk - the business is in the process of conforming to the required environmental compliance criteria
• High risk - the business has not fulfilled its obligations regarding the required environmental compliance criteria

Question 14

What risks are associated to Legal Compliance?

Answer 14

• Low risk - the business is fully compliant with all laws or regulations currently in force
• Moderater risk - the business is taking the necessary steps to become compliant with laws that are about to come onto the statute book and is in progress to become fully compliant in the next few months with recent laws or regs now on the statute book.
• High risk - the business is not compliant with material regs or laws

Question 15

What risks are associated to Credit Compliance Breach?

Answer 15

• Low risk - business consistently meets all the terms and conditions of its credit or loan agreement
• Moderate risk - business meets all the major loan covenants but from time to time nay fail to comply with minor ones, e.g. insurance cover has expired, but is being renewed
• High risk - now and then the business breaches a significant term or condition of the credit or loan agreement

Question 16

What risks are associated to Credit Covenant Breach?

Answer 16

• Low risk - at this date no covenants have been breached
• Moderate risk - at this date 1 covenant has been breached
• High risk - at this date 2+ covenants have been breached

Question 17

What risks are associated to Business Credit Reputation?

Answer 17

• Low risk - payments to creditors are met before or within agreed terms
• Moderate risk - indiciations are that payments have extended beyond the agreed terms on an infrequent basis
• High risk - credit checks indicate that the business is consistently late, without cause, in paying its suppliers

Question 18

What risks are associated to Business Plan Success/Dealing with Catastrophes?

Answer 18

• Low risk - both short and long term business plans have been very well executed resulting in strong business performance
• Moderate risk - implementation of the business plan is generally acceptable. While the business plan addresses normal problems, there is no mention of specific issues. As a result sometimes the business is unable to acheive forecasted performance.
• High risk -
  
  • ​No plan - management has not prepared a formal business plan dealing with the important business and competitive issues
  • Plan untested - although a formal business plan is in place, it hasn’t been tested because the business has only been newly established with no track record or because of a lack of cyclical/competitive experience
  • Unsuccessful - implementation of a business plan has been ineffective causing loss of market position, disruption within the business and financial detioration

Question 19

What risks are associated to Captial Expenditure/Technology?

Answer 19

• Low risk - production assets, core fixed assets are maintained in a good conditions, are regularly maintained, and there is a recognised cycle for a placement. Fixed assets useage under 60%
• Moderate risk - productions assets, core fixed assets are maintained in fairly good order, maintenance is satisfactory, there have been a few breakdowns which have disrupted production and the replacement cycle has not always been adhered to. Fixed assets useage % approaching 60% or 66%
• High risk - production assets, core fixed assets are poorly maintained, regular maintenance schedules fall behind, breakdowns happen fairly often disrupting production and the replacement cycle is behind schedule. Fixed assets useage % exceeds 66%