types of corporate Loans

8/19/2019 types of corporate Loans

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may terminate the facility at any time, depending on state la! or legal precedents. re ol ing line of credit is alid for a stated period of time and does not ha e a

(xed repayment schedule, but usually has a required fee. &he lender has lesscontrol o er a re ol ing credit since there is an embedded guarantee 1i.e. (rmcommitment2 to make ad ances !ithin the prescribed limits of the loan agreement.

&he borro!er may recei e periodic ad ances under the line of credit or there ol ing credit up to the agreed limit. epayment is generally accomplishedthrough the con ersion or turno er of short-term assets, such as in entory oraccounts recei able. nterest payments on !orking capital loans are usually paidthroughout the term of the loan, such as monthly or quarterly.

%orking-capital loans are intended to be repaid through the cash 3o! deri ed fromcon- erting the (nanced assets to cash. &he structure of the loans can ary, butthey should be closely tied to the timing of the con ersion of the (nanced assets. nmost cases, !orking-capital facilities are rene!able at maturity, are for a one-yearterm, and include a clean-up requirement for a period sometime during the lo!point or contraction phase of the business cycle. &he clean-up period is a speci(edperiod 1usually 45 days2 during the term of the loan in !hich the borro!er isrequired to pay o the loan. %hile this requirement is becoming less common, itpro ides the branch !ith proof that the borro!er is not dependent on the lender forpermanent (nancing. t is important to note, ho!e er, that an expanding businessmay not be able to clean up its facility since it may be increasing its current assets.

nalysis of %orking-$apital /oans

&he analysis of a !orking-capital loan is best accomplished by a monthly orquarterly re ie! of a company6s balance sheet and income statements to identifythe peak and contraction phases of the business cycle. &he lender should kno!!hen the peak and contraction phases are, and

the loan should be structured accordingly. &he lender6s primary objecti e is todetermine !hether the ad ances are being used for the intended purposes1in entories or payables2 and not for the acquisition of (xed assets or payments onother debts. epayments on the facility should also be consistent !ith thecon ersion of assets. f the borro!er has other loan facilities at the branch, all credit


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facilities should be re ie!ed at the same time to ensure that the acti ity !ith the!orking-capital facility is not used to pay interest on other loans in the branch.Projections of sources and uses of funds are also a aluable tool for re ie!ing a!orking-capital line of credit and determining the sales cycle.

7uarterly balance-sheet and income statements are ery helpful !hen acomparison is made !ith the original projections. 'ther helpful information can beobtained from a re ie! of an aging of accounts recei able for delinquen- cies andconcentrations, a current list of in entory, an accounts-payable aging, andaccruals made during the quarter. &his information can be compared !ith theoutstanding balance of the facility to ensure that the loan is not o erex- tended andthat the collateral margins are consistent !ith borro!ing-base parameters.

borro!ing base is the amount the lender is !illing to ad ance against a dollaralue of pledged collateral8 for example, a branch !ill only lend up to a

predetermined speci(ed percentage of total outstanding recei ables less all

accounts more than a certain number of days delinquent. borro!ing-basecerti(cate should be compiled at least monthly or more often during peak acti ity inthe facility. %hen re ie!- ing !orking-capital loans, examiners should rememberthat a branch relies hea ily on in entory as collateral in the beginning of a compa-ny6s business cycle and on recei ables to!ard the end of the business cycle.9o!e er, in traditional !orking-capital loans, greater empha- sis is usually placedon accounts recei able as collateral throughout the loan6s tenure.

0ormally, a branch is secured by a perfected blanket security interest on accountsrecei able, in entory, and equipment, and on the proceeds from the turno er ofthese assets. %ell- capitali#ed companies !ith a good history of payout or cleanupmay be exceptions and qualify for unsecured lending. n annual lien search,ho!e er, !ould be prudent under this type of lending relationship to detect anypurchase money security interest that may ha e occurred during the business cycle.

&he follo!ing are potential problems associ- ated !ith !orking-capital loans:

; %orking-capital ad ances used for funding losses. business uses ad ancesfrom a re ol ing line of credit to fund business losses, including the funding of!ages, business expenses, debt ser ice, or any other cost not speci(callyassociated !ith the intended pur- pose of the facility.

; %orking-capital ad ances funding long-term assets. business !ill use!orking-capital funds to purchase capital assets that are nor- mally acquired !ithterm business loans.


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; &rade creditors not paid out at end of business cycle. %hile the branch maybe paid out, some trade creditors may not get full repayment. &his can cause astrained relationship as unpaid trade creditors may be less !illing to pro ide(nancing or o er fa orable credit terms in the future. n turn, the business !illbecome more reliant on the branch to support funding needs that !ere pre iously

(nanced by trade creditors.

; ' erextension of collateral. &he business does not ha e the collateral tosupport the extension of credit, causing an out-of-borro!ing-base situation."xaminers should re ie! borro!ing- base certi(cates to erify that co erage meetsthe prescribed limitations established by the branch6s credit policy for the speci(cassets being (nanced.

;


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142 /iquidate the collateral. *oreclosing on the collateral should only be executed!hen it becomes ob ious that the business can no longer function as a goingconcern. &he problem !ith this option is that once the branch disco ers that thebusiness is no longer a iable concern, reali#ing the full alue of the collateral is in

jeopardy. &he need to resort to any of these options !ill usually prompt criticism of

the credit.

&erm /oans

&erm loans are generally granted at a (xed or ariable rate of interest, ha e amaturity in excess of one year, and are intended to pro ide an organi#ation !ith the

funds needed to acquire long-term assets, such as physical plants and equipment,or (nance the residual balance on lines of credit or long-term !orking capital. &ermloans are repaid through the business6s cash 3o!, according to a (xed-amorti#ationschedule, !hich can ary based on the cash-3o! expectations of the underlyingasset (nanced or the anticipated pro(tability or cash 3o! of the business. &ermloans in ol e greater risk than short-term ad ances because of the length of timethe credit is extended. s a result of this greater risk, term loans are usuallysecured. /oan interest may be payable monthly, quarterly, semiannually, orannually. /oan principal should amorti#e !ith the same frequency in order to fullypay o the loan at maturity.

n most cases, the terms of these loans are detailed in formal loan agreements !itha@rmati e and negati e co enants that place certain conditions on the borro!erthroughout the term of the loan. n a@rmati e co enants, the bor-

ro!er pledges to ful(ll certain requirements, such as maintain adequate insuranceco erage, make timely loan repayments, or ensure the (nancial stability of thebusiness. 0egati e or restricti e co enants prohibit or require the borro!er torefrain from certain practices, such as selling or transferring assets, defaulting, fall-ing belo! a minimum debt co erage ratio, exceeding a maximum debt-to-equityratio, or taking any action that may diminish the alue of collateral or impair thecollectibility of the loan. $o enants should not be !ritten so restricti ely that theborro!er is constantly in default o er tri ial issues8 ho!e er, iolations should bedealt !ith immediately to gi e credibility to the agreement.


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agreement does not exist, the term loans should be !ritten !ith shorter maturitiesand balloon payments to allo! more frequent re ie! by branch management.

nalysis of &erm /oans

%hile a !orking-capital loan analysis empha- si#es the balance sheet, the analysisof term loans !ill focus on both the balance sheet and the income statement.Aecause a term loan is repaid from excess cash 3o!, the long-term iability of thebusiness is critical in determining the o erall quality of the credit. n e aluat- inglong-term earnings, the examiner must de elop a fundamental understanding of thecompany6s industry and competiti e position in the marketplace. +ost of the

analysis !ill be conducted based on the historical performance of the business andits history of making payments on its debt. ny historical record of inconsistenciesor inability to perform on exist- ing debt should prompt an in-depth re ie! todetermine the ability of the borro!er to meet the loan6s contractual agreements.'ne of the most critical determinations that should be made !hen e aluating termdebt is !hether the term of the debt exceeds the useful life of the underlying assetbeing (nanced.

%hile cash 3o! of the business is the primary source of repayment for a term loan,a secondary source !ould be the sale of the underlying collateral. 'ften, ifcircumstances !arrant a collateral sale, the branch may face steep dis-

counts and signi(cant expenses related to the sale. "xaminers should carefullyconsider these issues !hen e aluating the underlying alue of collateral under aliquidation scenario.

&he follo!ing are potential problems associ- ated !ith term loans:

; &he term of the loan is not consistent !ith the useful life of collateral.

; $ash 3o! from operations does not allo! for adequate debt amorti#ation, afundamental problem that can be sol ed only by impro ed performance.


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; &he gross margin of the business is narro!- ing, !hich requires the businessto sell more product to produce the same gross pro(t. 9igher sales olume couldrequire more cash for expansion of current assets, lea ing less cash for debtamorti#ation. &his situation is a common by-product of increased competition.

; Sales are lo!er than expected. n the face of lo!er sales, management isunable or un!illing to cut o erhead expenses, straining cash 3o! and resulting indiminished debt ser ic- ing ability.

; *ixed assets that are (nanced by term loans become obsolete before theloans are retired, likely causing the alue of underlying collateral to deteriorate.

; &he business6s excess cash is spent on higher salaries or other unnecessaryexpenses.

; &he payments on term debt ha e put a strain on cash 3o!, and the businessis unable to adequately operate or allo! natural expansion.

; &he balance sheet of the business is !eaken- ing. &he o erall (nancialcondition of the business is deteriorating because of poor performance orunforeseen occurrences in the industry.

Shared 0ational $redits

egulatory agencies participate in a program for the uniform re ie! of sharednational credits 1S0$2. S0$ is de(ned as any loan, commitment, or group ofloans or commitments aggre- gating B?5 million or more at origination that is:

; $ommitted under a formal lending arrangement.

; Shared at its inception by t!o or more super- ised institutions or sold toone or more

institutions !ith the purchasing entity assum- ing its pro rata share of the creditrisk.

single facility !ith di erent terms andCor participants for tranches should bereported as separate credits. /oans sold to a@liate banks of the same holdingcompany are not part of the S0$ program.


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f the outstanding balance or commitment of a S0$ falls belo! B?5 million after itsinception, and it is not critici#ed, the credit !ill not be re ie!ed at the next re ie!date. &herefore, the examiner should conduct an indi idual re ie! of the credit atthe branch under examination. 9o!e er, if the former S0$ facility fell belo! thethreshold through a charge-o , and !as classi(ed or specially mentioned at the

most recent S0$ re ie!, the credit relationship !ould continue to be re ie!edunder the S0$ program until such time that the balance falls belo!

B>5 million. &he *ederal =eposit nsurance $orporation 1*= $2, the state agencies,and the '@ of the $omptroller of the $urrency 1'$$2 also participate in thisprogram. &he *ederal eser e carries out the examination of S0$s at the lead oragent banks that are state-member banks, state-chartered foreign branches, andcredit-extending nonbank subsidiaries of domes- tic and foreign organi#ations. &he*= $ is primarily responsible for any S0$ credits at state non-member banks, andthe '$$ super- ises the re ie! of those S0$s in !hich the lead bank is a nationalbank or an '$$-chartered foreign branch.

S0$s should not be analy#ed or re ie!ed during the examination of the indi idualpartici- pating branch. f the examiner is uncertain !hether the credit !as re ie!edunder the S0$ program, the respecti e eser e Aank coordinator should becontacted. f credits eligible for the program are found but ha e not been re ie!ed1other than ne! S0$s since the time of the last S0$ program re ie!2, the examinershould submit a memorandum detailing those credits to the respecti e eser eAank coordinator to be for!arded to the S0$ coordinator at the *ederal eser eAank of 0e! )ork.

&he S0$ program does not track subpartici- pations. subparticipant is a bankingorgani#a- tion that has purchased a share from either a bank in the originalsyndicate or from a bank considered a (rst-tier participant. &herefore, if the bank isa subparticipant in a credit, it !ill not appear in the DD eport of /enders and theirAorro!ers66. 9o!e er, the credit may ha e been

re ie!ed by the S0$ Program and examiners can obtain the results of such a re ie!by calling the S0$ coordinator for their agency.


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S"$E "= 0= E0S"$E "= & 0S $& '0S

&his subsection is intended to be a general reference for an examiner6s re ie! of acredit (le to determine !hether the branch6s collateral position is properlydocumented. "xaminers should be a!are that secured transactions encompass an

extensi e body of la! that is rather technical in nature. &he follo!ing discus- sioncontains general information for examiners on the basic la!s that go ern a branch6ssecurity interest in property and on the documentation that needs to be in a loan(le to properly document a perfected security interest in a borro!er6s assets.

Secured &ransactions

+ost secured transactions in personal property and (xtures are go erned by article

F of the Eniform $ommercial $ode 1E$$2. &he E$$ has been adopted by all 5states, the =istrict of $olumbia, and the


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&he three requirements for the creation of a security interest are stated in E$$section F-?541>2. 'nce the follo!ing requirements are met, the security interest isattached.

; &he collateral is in the possession of the secured party pursuant toagreement, or the debtor has signed a security agreement that contains adescription of the collateral and, !hen the security interest co ers crops no!gro!ing or to be gro!n or timber to be cut, a description of the land concerned.

; >52. &he agreement must also be signed by the debtor. &hecreditor may sign it, but its failure to do so does not a ect the agreement6senforceability against the debtor.

Gi ing alue is any consideration that sup- ports a contract.


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the collateral. &he category of collateral !ill dictate the method of perfection to beused. &he most common methods of perfection are: 1>2 automatic perfection !henthe security interest is attached 1such as in the case of purchase-money securityinterests applicable to consumer goods other than ehicles28

1?2 perfection by possession8 142 the (ling of a (nancing statement in one or morepublic (ling o@ces,> and 1I2 compliance !ith a state certi(- cate of title la! orcentral (ling under a state statute other than the E$$, such as registration of

ehicles.

&he most common method of perfecting a security interest is public (ling. Public(ling ser es as a constructi e notice to the rest of the !orld that the branch claimsa security interest in certain property of the debtor described in both the securityagreement and the (nancing statement. Public (ling is accomplished by (l- ing a(nancing statement 1E$$->2 in a public o@ce, usually the county recorder orsecretary of state. &he system of (ling required by the E$$ pro ides for a notice (

!hereby potential creditors can determine the existence of any outstanding liensagainst the debtor6s property.

&he form of the (nancing statement and !here to (le it aries from state to state.%hile the (ling of a nonstandard form !ill generally be accepted, the failure to (lein the proper public o@ce can jeopardi#e the priority of the lender6s securityinterest. &he E$$ pro ides three alternati e (ling systems:

; lternati e System 'ne. /iens on minerals, timber to be cut, and (xtures are(led in the county land records. ll other liens are (led in the o@ce of the secretaryof state.

; lternati e System &!o. &he majority of states ha e adopted this ersion. t isthe same as system one, except liens on consumer goods, farm equipment, andfarm products are (led in the county !here the debtor resides, or in the

>. &he (nancing statement is good for ( e years, and the

county !here the collateral is located if it is o!ned by a nonresident.

; lternati e System &hree. n a fe! states, (lings made !ith the secretary ofstate must also be (led in the county of the borro!er6s business 1or residence if


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there is no place of business in that state2. 'ther!ise, the requirement in thesestates is the same as system t!o.

s each state may select any of the abo e three alternati es or a modi(ed ersionof them, it is important that the examiner ascertain the (ling requirements of thestate1s2 !here the branch6s customer operates. +ost importantly, it is the locationof the borro!er, not the branch, that determines !here the (nancing statementmust be (led.

" aluation of Security nterest in Property

Jey items to look for in e aluating a security interest in property include thefollo!ing:

; Security agreement. &here should be a proper security agreement, signedand dated by the borro!er, that identi(es the appropriate collateral to be secured.

t should include a description of the collateral and its location in su@cient detail sothe lender can identify it, and should assign to the lender the right to sell or disposeof the collateral if the borro!er is unable to pay the obligation.

; $ollateral possession. f the institution has taken possession of the collateralto perfect its security interest, management of the institution should ha e anadequate record-keeping system and proper dual control o er the property.

; *inancing statement. f the institution has (led a (nancing statement !ith thestate or local authority to perfect its security interest in the collateral, in general, itshould contain the follo!ing information:

H names of the secured party and debtor

H the debtor6s signature

H the debtor6s mailing addressH the address of the secured party from !hich information about the securityinterest may be obtained

H the types of the collateral and description of the collateral?


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lender must (le for a continuation !ithin the six-month period

before expiration of the original statement. ?. Substantial compliance !ith therequirements of E$$

; mendments. 0ot all amendments require the borro!er6s signature, andbranches may (le an amendment for the follo!ing reasons:

H borro!er6s change of address

H creditor6s change of address

H borro!er6s name change

H creditor6s name change

H correction of an inaccurate collateral description

H addition of a trade name for the borro!er that !as subsequently adopted

; %here to (le a (nancing statement. n general, (nancing statements (led ingood faith or (nancing statements not (led in all of the required places are stille ecti e. f a local (ling is required, the o@ce of the recorder in the county of thedebtor6s residence is the place to (le. f state (ling is required, the o@ce of thesecretary of state is the place to (le.

; =uration of e ecti eness of a (nancing statement. Generally, e ecti enesslapses ( years after (ling date. f a continuation statement is (led !ithin six monthsbefore the lapse, e ecti eness is extended ( e years after the last date on !hichthe (ling !as e ecti e. Succeeding continuation statements may be ( to furtherextend the period of e ecti eness.

Perfection of Security nterest in eal "state

s pre iously mentioned, real estate is expressly excluded from co erage under theE$$. separate body of state la! co ers such interests. 9o!e er, for a real estate


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mortgage to be enforceable, the mortgage must be recorded in the county !herethe real estate co ered by the mortgage is located.

eal estate mortgageCdeed of trust. %hen obtaining a alid lien on real estate, onlyone document is used, the mortgage or deed of trust. &he di erence bet!een amortgage and a deed of trust aries from state to state8 ho!e er, the primarydi erence relates to the process of foreclosure. mortgage generally requires a

section F-I5? is su@cient if errors are only minor and not seriously misleading.

Some states require the debtor6s tax = number on the (nancing statement.

judicial foreclosure, !hereas, in some states, a foreclosure on a deed of trust maynot. 0early all matters a ecting the title to the real estate, including the o!nershipthereof, are recorded in the recorder6s o@ce.

%hen determining the enforceability of a real estate mortgage or deed of trust, theexaminer should be a!are of the follo!ing requirements:

; &he mortgage must be in !riting.

; &o be recordable, the mortgage must be ackno!ledged. &here are di erentforms of ackno!ledgments for arious situations depending on !hether indi iduals,corpora- tions, partnerships, or other entities are executing the mortgage. +akesure that the form of the ackno!ledgment used is in accordance !ith the type ofindi idual or entity executing the mortgage.

; f a corporation is the mortgagor, its articles of incorporation or byla!s often!ill speci(cally state !hich o@cers ha e authority to sign an instrument a ecting

real estate. n these instances, the designated o@cer should be required to sign. fthe corporation has a seal, that also must be a@xed. f the corporation does notha e a seal, this fact must be sho!n in the ackno!ledgment.

; s soon as possible after the mortgage is executed, it should be recorded inthe o@ce of the recorder for each county in !hich the property described in themortgage is located. n most cases, the borro!er signs an a@da it that indicates, inpart, that he or she !ill not attempt to encumber the property !hile the lender is


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!aiting for the mortgage to be recorded. n any e ent, the lender should conduct atitle search after the mortgage is recorded to ensure that his position has not beencompromised.

; f the mortgagor is married, the spouse must join in the execution of themortgage to subject his or her interest to the lien of the mortgage. f the mortgagoris single, the mortgage should indicate that no spouse exists !ho might ha e ado!er interest or homestead interest in the property.

; f the mortgagor is a partnership, it must be determined !hether the title is inthe name of the partnership or in the names of the indi- idual partners. f the titleis in the names of the indi idual partners, their spouses should join in executing themortgage. f the title is in the name of the partnership, those partners

!ho are required to sign under the partnership agreement should sign.

Ensecured &ransactions

Ensecured transactions are granted based on the borro!er6s (nancial capacity,credit history, earnings potential, andCor liquidity. ssignment of the borro!er6scollateral is not required, and repayment is based on the terms and conditions ofthe loan agreement. %hile unsecured loans often represent the branch6s strongestborro!- ers, the unsecured loan portfolio can represent its most signi(cant risk. 'neof the primary concerns related to unsecured credit is that if the borro!er6s (nancialcondition deteriorates, the lender6s options to !ork out of the lending relationshipdeteriorate as !ell. n general, if a credit is unsecured, the (le should containreliable and current (nancial information that is su@cient to indicate that theborro!er has the capacity and can be reasonably expected to repay the debt.

"merging Problem /oans

&he follo!ing are key signals of an emerging problem loan:


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; 'utdated or inaccurate (nancial information. &he borro!er is un!illing topro ide the (nancial institution !ith a current, complete, and accurate (nancialstatement at least annually. +anagement also should request a personal tax

return 1and all related schedules2 on the borro!er. %hile borro!ers !ill usuallypresent their personal (nancial statements in the most fa orable light, their incometax return pro ides a more conser ati e picture.

; &he crisis borro!er. &he borro!er needed the money yesterday, so thebranch ad anced unsecured credit.

; 0o speci(c terms for repayment. &he unsecured loan has no structure forrepayment, and it is commonly rene!ed or extended at maturity.

; Ende(ned source of repayment. epayment sources are often not identi(edand are unpre- dictable. &hese types of loans are often repaid through excess cash3o! of the borro!er, sale of an asset1s2, or loan proceeds from another (nancialinstitution.

"< "% 0G $ "= & 7E / &)

mportance of $ash *lo!

" aluating cash 3o! is the single most important element in determining !hethera business has the ability to repay debt. &!o principal methods of calculating thecash 3o! a ailable in a business to ser ice debt are presented in this subsection.

&he results of these methods should be used to determine the adequacy of cash3o! in each credit e aluated at an institution. &he accrual con ersion method is thepreferred method because it is the most reliable. &he second and less reliablemethod is the supple- mental or traditional cash-3o! analysis8 ho!- e er, theinformation needed for this analysis is usually more obtainable and easier tocalculate. &he traditional method can be used !hen cir- cumstances !arrant, forexample, !hen the borro!er6s (nancial statements are not su@- ciently detailed forthe information requested in the accrual con ersion analysis or !hen histori- calinformation is inadequate.

nalysis and /imitations of $ash *lo!


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$ash-3o! analysis uses the income statement and balance sheet to determine aborro!er6s operational cash 3o!. $areful analysis of all in estment and (nancing1borro!ing2 acti ities must be made for an accurate assessment of cash 3o!. n

reality, examiners face time constraints that often pre ent them from performingthe complex mathematical calculations in ol ed in sophisticated cash-3o! analysis. &herefore, the cash-3 methods presented belo! !ere designed to be reasonableand practical for examiner use. 9o!e er, examiners should be careful ofconclusions reached using the traditional cash-3o! analysis, !ithout considerationof balance-sheet changes or other acti ities that a ect cash 3o!. &he traditionalcash-3o! analysis does not recogni#e gro!th in accounts recei able or in entory,a slo!-do!n in accounts payable, capital expenditures, or additional borro!ings. fthe credit (le contains a $P - prepared statement of cash 3o! or a statementprepared using the accrual con ersion method, the examiner should concentratee orts on re ie!ing and analy#ing these statements rather

than on preparing a traditional cash-3 statement.

'ne critical issue to remember is that de(cit

"xcess 1=e(cit2

$ash *lo!: epresents cash a ailable before debt ser ice.

cash 3o! does not al!ays mean that the bor-

ro!er is encountering serious (nancial di@cul- ties. n some cases, de(cit cash 3o!is caused by a business6s experiencing signi(cant gro!th,


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and there is a pronounced need for external ( to accommodate this gro!thand elimi-

$alculation of

SupplementalC&raditional $ash *lo!

nate the de(cit cash-3o! position. n this case,

an adequate !orking-capital facility may not be

in place to accommodate the need for additional in entory. comprehensi e

analysis of changes in the balance sheet from period to period should be madebefore the loan is critici#ed.

0et ncome: mount of net income reported

on most recent annual income statement before taxes.

nterest

"xpense: dd the total amount of interest

expense for the period.

$omponents of the ccrual $on ersion +ethod of $ash *lo!

=epreciationC

morti#ation: dd all noncash depreciation

and principal amorti#ation on outstanding debt.

$ategory Aasis for mount


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Sales: =ollar amount of sales in period

KCchange in C , 0


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and is subtracted from the

calculation.

SG : Subtract selling, general, and

nterest

administrati e expenses.

mportance of *inancial nalysis

"xpense: dd interest expense to the cal-

culation if SG DDexpense66 includes interest expense.

%hile cash-3o! analysis is critical in re ie!ing !hether a borro!er has the ability torepay indi idual debt, a re ie! of the borro!er6s other

(nancial statements can o er information about other sources of repayment, as!ell as the borro!er6s o erall (nancial condition and future prospects. &hea ailability of historical balance- sheet and income information, !hich allo!

declining trends to be identi(ed, is critical. lso, it may be appropriate to comparethe borro!er6s (nancial ratios !ith the a erage for the industry o erall. +uch of the(nancial information that examiners !ill re ie! !ill not be audited8 therefore,considerable understanding of general accounting principals is necessary to compe-tently re ie! an unaudited (nancial statement. t a minimum, (nancial statementsshould be obtained annually8 !here appropriate, the branch also should obtainmonthly or quarterly statements.


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%hen re ie!ing a credit (le of a borro!ing customer of a branch, the follo!ing(nancial information should be a ailable for re ie!: income statement, balancesheet, reconciliation of equity, cash-3o! statements, and applicable notes to(nancial statements. &he components for a (nancial re ie! can be segregated intothree areas: operations management, asset management, and liability

management. 'perations management is deri ed from the income statement andcan be used to assess company sales, cost control, and pro(tability. sset manage-ment in ol es the analysis of the quality and liquidity of assets, as !ell as theasset mix. /iability management co ers the analysis of the company6s record ofmatching liabilities to the asset con ersion cycle, such as long-term assets beingfunded by long-term liabilities.

n studying these forms of management, arious ratios !ill help the examiner forman informed and educated conclusion about the quality of the credit being re ie!ed.

&he ratios can be di ided into four main categories:

; Pro(tability ratios. &hese ratios measure man- agement6s e@ciency inachie ing a gi en le el of sales re enue and pro(ts, as !ell as management6sability to control expenses and generate return on in estment. "xamples of theseratios include gross margin, operating pro(t margin, net pro(t margin, pro(t-to-sales ratio, pro(t-to-total assets ratio, and direct cost and expense ratios.

; "@ciency ratios. &hese ratios, !hich measure management6s ability tomanage and control assets, include sales to assets, in entory days on hand,accounts recei able days on hand, accounts payable days on hand, sales to net

(xed assets, return on assets, and return on equity.

; /e erage ratios. &hese ratios compare the funds supplied by business o!ners!ith the (nancing supplied by creditors, and measure debt capacity and ability tomeet obligations. &hese ratios may include debt-to-assets, debt- to-net-!orth, debt-to-tangible-net-!orth, and interest co erage.

; /iquidity ratios. nclude ratios such as the current ratio and quick ratio, !hichmeasure the borro!er6s ability to meet current obligations.

$ommon DD ed *lags66

&he symptoms listed belo! are included to pro ide an understanding of thecommon problems or !eaknesses examiners encounter in their re ie! of(nancial information. %hile one symptom may not justify critici#ing a loan, !hen


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symptoms are considered in the aggregate, they may help the examiner detectnear-term trouble. &his list is only a sampling of Lred 3agsL that should promptfurther re ie!8 examiners should also be able to identify issues that may requirefurther in estigation from their cursory re ie! of a borro!er6s ( statement.

; slo!do!n in the recei ables collection period. &his symptom often re ealsthat the borro!er has become more liberal in estab- lishing credit policies, hassoftened collection practices, or is encountering an increase in uncollectedaccounts.

; 0oticeably rising in entory le els in both dollar amount and percentage oftotal assets. ncreases in in entory le els are usually sup- ported by trade suppliers,and (nancing these increases can be extremely risky, particularly if turno er ratiosare declining. &he increase in in entory le els or lo!er turno er ratios may also berelated to the borro!er6s natural reluctance to liquidate excessi e or obsolete goodsat a reduced price. +any businesses are !illing to sacri(ce liquidity to maintain

pro(t margins.

; Slo!do!n in in entory turno er. &his symptom may indicate o erbuying orsome other imbalance in the company6s purchasing policies, and it may indicatethat in entory is slo!-mo ing. f the in entory is under alued, the actual turno er ise en slo!er than the calculated results.

; "xistence of hea y liens on assets. " idence of second and third mortgageholders is a sign of greater-than-a erage risk. &he cost of junior money is high. +ostborro!ers are reluctant to use this source of funds unless con entional sources areuna ailable.

; $oncentrations of noncurrent assets other than (xed assets. company mayput funds into a@liates or subsidiaries for !hich the branch may not ha e a readysource of information on operations.

; 9igh le els of intangible assets. ntangible assets, !hich shrink or anish

much more quickly than hard assets, usually ha e ery uncertain alues in themarketplace. n some cases, ho!e er, intangible assets such as pat- ents ortrademarks ha e signi(cant alue and should be gi en considerable credit.

; Substantial increases in long-term debt. &his symptom causes increasingdependence on cash 3o! and long-term pro(ts to support debt repayment.


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types of corporate Loans

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