Presented by:

Chuck Nwokocha Senior Risk Management Consultant

Financial information company that provides credit and risk management solutions to financial institutions

Data and applications used by thousands of financial institutions, corporations and accounting firms across North America

Awards Named to Inc. 500 list of fastest growing privately held

companies in the U.S.

Named to Deloitte’s Technology Fast 500

Chuck is a graduate of Harvard University, with a B.A. in Psychology with a focus in Organizations and Economics. He began his professional career with Guardsmark, a private security services company where he held various positions and responsibilities – in operations, human resources, and sales, and management. He has founded two e-commerce sites, Ndekanyi.com – a social networking site for the Igbo people and SwapU.com – a college classifieds network. Additionally, he has consulted on marketing, social media, and user-generated content.

At Sageworks, Mr. Nwokocha is an expert credit & risk management consultant helping financial institutions manage their loan portfolio , focusing on the Allowance for Loan and Lease Losses (ALLL), Stress Testing, Credit Analysis, Risk Rating, , and Loan Administration management. With subject-matter expertise, he helps financial institutions understand and comply with federal accounting guidance.

Chuck Nwokocha Senior Risk Management

Consultant

Enhancing Your Credit Quality 1. 3 P’s: Policies, Process, People 2. 5 C’s

a. 5 C’s of Credit b. 5 C’s of Data Collection c. Credit Risk Modeling

3. Considerations for Underwriting a. Documentation for Underwriting b. Considerations for Underwriting c. Tools for Analysis

4. Lending Environment a. Loan Portfolio Composition b. Loan Growth by Loan Type c. Survey Results d. Emerging Trends e. Important Ratios in C&I

5. Examinations a. Examination concerns with C&I

6. Bankers’ Advice

4

Policies Sound underwriting

Process An efficient, balanced approval process

People A competent lending staff

Certified mail must be delivered

to X-person.

Mail/delivery requiring signatures must be

signed by a VP

Outgoing mail to IRS must be delivered with a confirmation receipt

Provide the framework for the bank’s lending activities Set the standards for portfolio composition, individual credit

decisions, fair lending, and compliance management Supplemented by more detailed underwriting standards,

guidelines, and procedures

Refers to a particular way in which something is done

Refers to a way of doing something

Establishes the lending process Assigns accountability and establishes the responsibilities of

the people involved

Mail gets delivered every day.

When the mail is delivered, it is sorted.

The sorting is determined by dept and purpose for

each piece

A competent lending staff

Refers to the individuals executing the process

Policy Provide the framework for

the bank’s lending activities. Sets the

underwriting standards for the credit decisions

Process Policy establishes the lending process and

the responsibilities of the people

People The individuals executing the

process Training Knowledge/ skills

required to execute the process and use a

procedure

Tools The Tools used in

the execution of the process

The lending staff, with the knowledge and skills, utilizing various tools, arrive at

quality loan decisions.

Capacity Measures a borrower’s ability to repay a loan by comparing

income against recurring debts

Can the borrower generate adequate cash to repay the loan?

Capital Refers to the net worth, or equity, of a business

Is the borrower adequately capitalized within industry standards to withstand unexpected loss?

Conditions The economic, industry, and market environment can and will

change; the state of the borrower or the state of the economy

Is the borrower flexible enough to adapt?

Collateral Helps secure the debt.

Is there an alternative source of repayment in case the primary source fails?

Character Personal integrity of business owners and officers

Is management willing to repay the loan and will it attempt to do so under adverse conditions?

Credit Risk

Determining risk factors

Understanding credit quality (risk grading/risk rating)

Likelihood that a business/borrower/relationship may default on its financial obligations

Model should account for different types of loans as well as industries (diff industries require diff capital structures)

A complete picture of the financial condition of a small business requires a careful review of income statement and balance sheet information for both the guarantor and the business. Personal assets are often pledged against the debt of the business, and business and guarantor financial assets occasionally are intertwined.

Global Cash Flow Analysis

It’s common for owners to lend personal funds to, or borrow funds from, their businesses.

It’s common for the business (for tax advantages, primarily) to rent its office/warehouse/production facilities from a real estate holding company or partnership controlled by the business owners.

It’s common for owners to control their own levels of salaries, bonuses, benefits, and dividends to the extent allowed by prudence and tax regulations.

Annual Reviews Set a minimum review period that allows continual and

regular monitoring and reassessing of risk

The reviews will lead to early identification of deteriorating conditions

Trend Analysis Companies rarely remain in a static condition

Cash flow cannot be the only determinant

Credit analysis is much too complex to rely on just a single indicator

0

100

200

300

400

500

600

700

2007 2008 2009 2010 2011 2012

Growing Business

Deteriorating Business

A look at the trend is critical in determining if the business in growing or deteriorating.

Caliber Refers to the quality of the financials provided. What types of

financials?

- Audits - Reviews - Compilations

- Tax Returns - Company prepared

Complete Are all of the forms/ schedules present? Did the borrower provide

debt schedules?

Consistent Are the financials consistent? Did the borrower provide

compilations one year and tax returns another year?

Current Did the borrower provide the most recent financials?

Conversation Conversations with the borrower(s) help to cover those

gaps in information as well as provide supplemental explanation or lend additional insight

1. Financial information – used to establish repayment capacity

A. Business financials

-Current and historical income data, balance sheet

-Balance sheet, income and cash flow projections

-Comparative industry data when appropriate

B. Guarantor financials

-Guarantor support and related financial information

-Summary of borrower and affiliated credit relationships

2. Collateral identification and valuation

-Collateral agreements and appraisals

3. Loan structure information Loan terms, including tenor and repayment structure

Pricing information, including relationship profitability data

4. Loan agreement Covenants and requirements for future submission of financial data

Exceptions to policy and underwriting guidelines

Promissory notes, note guarantees

5. Supplemental Information Information fields to capture data for concentration reporting, identifying

SNCs (Shared national credits) etc.

Risk rating or recommended risk rating

Understanding financial statements and the significance of the ratios requires both skill and time

Translate financial numbers into meaningful assessments of company’s financial performance

Tackle these complex sets of information, condense the information into digestible chunks

Utilize software, such as the Sageworks Analyst solution

To input the information, to spread it into a consistent and standard format, and generate an analysis of the ratios

Concentrate on the key aspects of liquidity, leverage, and cash flow, using ratios, trends, and industry analysis to study them

22

Business(es) Personal

Guarantor(s) Real Estate

Global Cash Flow

Eliminate Double-Counting

Real Estate

Sageworks Analyst™ TruGlobal™ Credit Analysis

• Standardize cash flow analysis

• Improve accuracy

Sageworks Analyst™ TruGlobal™ Credit Analysis

• Standardize cash flow analysis

• Improve accuracy

Sageworks Analyst™ TruGlobal™ Credit Analysis

• Standardize cash flow analysis

• Improve accuracy

Sageworks Analyst™ TruGlobal™ Credit Analysis

• Standardize cash flow analysis

• Improve accuracy

Sageworks Analyst™ TruGlobal™ Credit Analysis

• Standardize cash flow analysis

• Improve accuracy

Combines multiple businesses,

people and properties to view global

cash flow and debt service numbers

Eliminates double-counting

Accurately

assesses impact

to Debt Service

Coverage Ratio

C&I loan competition intense and increasing

C&I and loan underwriting standards easing Net easing for 8 consecutive quarters.

CRE lending standards easing, but credit supply relatively tightened in 2012

C&I loan rate spreads decreasing 60% of bankers surveyed report ↓ spreads for loans to larger

businesses.

46% of bankers surveyed report ↓ spreads for loans to small businesses.

Regulatory authorities increasing exam scrutiny of C&I lending practices

Source: Federal Reserve Board “Senior Loan Officer Opinion Survey on Bank Lending Practices,” May 2013.

Longer terms with lower payments 15, 20, 25, & 30 Year Amortizations

3, 5, 10, 15 Year Fixed Rates

Fully amortizing; no balloons or calls

Preference for Owner-Occupied Properties or Investor Properties

Full collateral coverage not required Preference for up to 75% Loan to Value (LTV)

Minimum 1.25 DSCR

Personal Guarantees Full and unlimited personal guarantees from all owners of 20%+

Key Drivers of cash flow Sales (Revenue Growth)

Gross Margin

Accounts Receivables

Accounts Payables

Inventory Days

S, G & A (Selling, General, & Administrative Costs) – better known as overhead.

Capital Expenditure

Liquidity ratios Current ratio

Quick ratio

Working capital

Leverage ratios Debt service coverage

Interest coverage ratio

Debt to Equity Ratio

Efficiency ratios

Accounts Receivables days

Accounts Payables days

Inventory days

Profitability ratio Gross Profit and Gross Profit Margin

Inexperience with business entities

Financial data: what to collect, when

Industry specifications: what is normal for a particular industry

Global cash flow analysis methodology

Move from collateral to cash flow analysis

Avoid double-counting, while recognizing intermingled income and debt

Inadequate strategic planning

Policies & procedures account for C&I

New risk appetites

1. Re-evaluate concentration limits and risk appetite

2. Review Underwriting Policies

3. Train personnel, the board

4. Invest in technologies

5. Hire appropriately

6. Look outside the institution (potentially)

Asset quality is a huge area of focus by examiners

Main criticism areas included:

Risk rating systems

Higher rates of delinquent and non-performing loans

Loan reviews that weren’t completed annually or were inconsistent

Quality issues related to the financial institution’s growing pains,

the overall economy or continued real estate devaluation

Many comments relate to documentation of loan files, tracking information and global cash flow analyses:

“Document everything, even if you think it’s trivial.”

“Make sure all info is current.”

“Be on top of flood insurance and exceptions.”

“Document EVERYTHING.”

“Calculate twice, print once.”

“Focus on global cash flow and asset verification.”

“Policies should be written and followed.”

Bankers mentioned thorough documentation as a benefit. Among some other pieces: “Our exam did have some former OTS examiners, and there was

definitely a different approach taken by them. The lead reviewer had to focus them on the areas that really needed evaluated. They were picking on things in the file that were five years or older that were irrelevant to the credit risk today.”

“Need to remain patient and carefully explain Bank’s position. Prudently point out differences of opinions. Ask for clarification of criticisms.”

“Dinged for little things; need more documentation; did not like missing documents in loan files; better analysis.”

Presenter Contact Information:

Chuck Nwokocha, Sageworks

(919) 851-7474 ext. 637

chuck.nwokocha@sageworks.com

www.sageworksanalyst.com

Next Webinar:

Loan Workout 101 for Financial Institutions

Thursday, September 12, 2:00 PM EDT

http://web.sageworks.com/loan-workout-cooley/