The Chartered Institute of Bankers (Gh)

Carl T. Abruquah Meridian Consults

CREDIT ORIGINATION, APPRAISAL AND DISBURSEMENT

Agenda

Introduction Proposal Canons of Good lending Report Format Approval Term Sheet and Loan Agreement Disbursement Summary/Conclusion
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Introduction
Credit appraisal is a significant aspect of the credit management process. If a loan will go bad, it should be established

during the appraisal process so that any loss is prevented. A weak appraisal system will lead to a deterioration in the Banks credit portfolio Banks therefore provide standards for credit origination and appraisal
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Origination
The credit process commences when a customer submits a proposal or when a facility is due for renewal. The Banks relationship arm may also initiate proposals.
Referrals are a useful source of fresh

proposals.

Credit Origination Units

The credit origination units are normally the business arms of the Bank.
These include:
Corporate
SME Retail branches

Staff of these units have the duty of compiling all the requisite information about customer that is required to be submitted to the approving authorities
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Appraisal
There should be a structured system and format of appraisal.
Such a format will normally incorporate what

has become established as the fundamental principles of good lending or canons of good lending. Examples include CAMPARI and the five Cs.

CAMPARI
Character
Ability Margin or Means Purpose Amount Repayment Insurance

Character
Trustworthiness
Reliability Background and experience Track record Personal behavior

Ability
Ability to manage financial affairs
Skill and experience of management Balance of management skills Commitment of managements Experience in proposed area of activity

Margin
Pricing of facility
Volume of work involved in processing

proposal Riskiness of proposal Margin above reference rate e.g base rate

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Purpose
Acceptable
Working capital or long term capital? Illegal Industry concentration risks. Bank policy.

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Amount
Should be sufficient for purpose
If more or less than amount required may

result in waste or inability to undertake project. Should match purpose Have all expenses been taken into consideration? Customer contribution
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Repayment
Source of repayment should be made clear at the outset.
When source is cash flow from operations,

should be supported by a cash flow forecast. The Bank may have to develop its own cash flow in some circumstances. The Bank should be satisfied that the funds generated will be sufficient to cover repayment of the facility.
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Insurance/Security

Appropriate Readily realizable Adequate Should serve as safety net and not basis of approval of facility. Value should not be subject to wide fluctuations and should not deteriorate rapidly over time. Ease of valuation
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Report Format
Report should incorporate above principles. Staff should be given training regarding preparation of report and issues to be raised in report. There should be no political influence on the credit officer. It is normally in a memorandum format with a heading indicating e.g.

TO: CREDIT COMMITTEE FROM: SME NAME OF COMPANY: DATE

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Report Format
THE REQUEST
Purpose, amount of credit, source of repayment

Background of borrower

Credit assessment of the borrowers products, industry and macro economic factors. Assessment of Management Profile
Key success factors or SWOT analysis
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Report Format
Financials

Historical Financial Analysis Analysis of forecast Analysis of repayment. Account Profitability

Account operations Track record/repayment history of borrower. Overall risk assessment Summary and recommendations. PREPARED BY
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Areas of Appraisal
Business Risks
Industry characteristics Competitive position of Product Management

Financial Risks

Financial condition Profitability Capital structure Present and future cash flows
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Evaluation Business Risks

Evaluation of Customers current strategy
Level of competition in the industry. Customers market share

Position of product in life cycle

Relative attractiveness of customers product Qualification, age and experience of management Balance of skills of management
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Financial Evaluation
Profitability
Liquidity Activity Solvency Cash flow coverage Shareholder ratios

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Profitability
Return on Capital employed - defined as the ratio of operating profits (Net Profit before interest and taxes) to total capital employed. This is normally defined as shareholders funds plus long term loans Return on equity net profit after taxes divided by shareholders equity. Gross Margin defined as gross profit divided by sales Operating Profit margin operating profit divided by sales
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Liquidity
The cash cycle is calculated as the trade cycle plus credit taken and given cycles The trade cycle is calculated as

Raw material Inventory days in stock, plus Production cycle, Finished goods days in stock The time to pay creditors is subtracted The time for debtors to pay is added, giving The cash cycle.
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Liquidity
The Cash cycle ratios are
Stock turnover stocks in hand divided by cost of goods

sold times 365 days Creditors days trade creditors divided by purchases times 365 days Debtors days trade debtors divided by sales times 365 days.

The liquidity ratios are

Current ratio - current assets divided by current

liabilities Quick ratio current assets less stocks divided by current liabilities.

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Solvency/Coverage
Leverage or gearing is calculated as either prior charge capital divided by equity or prior charge capital divided by total capital

(including long term loans) Interest cover net profit before interest and taxes divided by interest charges. Debt ratio total creditors (both long and short term) divided by Total Assets
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Stock Exchange Ratios

Dividend yield dividend per share divided by market price of share. EPS net profit per share divided by total

number of shares. Earnings yield earnings per share divided by market price per share. Price earnings ratio Market Price per share divided by earnings per share, reciprocal of EPS
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Financial Projections
Financial projections should be realistic in relation to current

performance. Most especially it should conform to industry growth rates and current level of sales. What is the limiting factor? How will the company be affected by economic conditions and cyclical trends? Has the effects of inflation been considered in drawing up the estimates How will inflation and competition affect the pricing policy? Does the budget reflect forecast demand of the business and market at large? Above all the projections should confirm customers ability to repay the facility

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Account Operation
Are sales receipts fairly regular and at a constant level or

increasing level. Irregular receipts may arise from seasonality of business, cash transactions or diversion of funds into another account with another Bank. Supplier payments should be fairly regular and of a constant or increasing level. Decreasing payments may arise from decreasing profitability or liquidity problems. Excessive increase may also arise from overtrading. Round sum payments mean the business is paying on account and may be facing liquidity problems.

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Account Statistics
Average balances, lowest and highest balance Does the account swing into credit, or is a hard core

developing? Is the hard core increasing in size? Is there a deterioration of the average balance? Largest debits and credits to the account Number of transactions per month and average monthly number Excesses over anticipatory or agreed limits Dormant borrowing perhaps customer has abandoned the account and is operating with another Bank How does the debit turnover compare with sales? Is the general pattern of the accounts changing?
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Approval
Approval levels
Decision
Approval

Decline
Restructuring of proposal

Clear audit trail Arms length basis

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Term Sheet
The term sheet can serve as a basis of negotiation between the bank and the customer. Once the borrower accepts the terms, they are considered as binding.
After the term sheet has been prepared, the

two parties will negotiate in further detail and the loan agreement drafted.
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Clauses in Term Sheet

Facility Commitment Fee Purpose of Loan Availability Interest rate payable Maturity/term repayment of loan capital Early repayment of loan capital Broad details of security to be provided Conditions precedent
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Clauses in Term Sheet

Covenants
Events of default Taxes Costs Confidentiality Assignment

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Areas of Negotiation
Price
Structure Security and guarantees Covenants Provisions for transfers or assignments

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Disbursement
An advance should only be disbursed after all documents have been executed and the necessary terms and conditions have been

met. Legal documentation e.g. relating to securities must be reviewed ideally by a specialized internal unit, before any loan or credit facility is disbursed.

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Summary/Conclusion
Banks should have in place structured procedures and formats for appraisal of customer proposals. This would go a long way to minimize the significant risk involved in granting credit. Banks have established canons or principles of lending that should govern the granting of credit. Any format for internal credit reports should incorporate these principles to ensure that a proposal is properly appraised and the right decision taken.
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THE END

THANK YOU
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