Key Components of Effective Credit Presentations
The credit presentation is an important part of a loan file, as it is used to summarize a borrower’s relationship with the bank, document loan approvals, and provide a review of the borrower’s financial performance. The credit presentation is reviewed by approving officers when making a loan decision, as well as by regulators and loan review personnel when reviewing the bank’s lending practices. Ideally the credit presentation will stand on its own, providing the reader sufficient information to understand the borrower.
There are some key components to include in a credit presentation to allow the reader to make an informed decision, as well as limit the number of follow up questions necessary to understand the transaction and/or the relationship.
1. History of the borrower and key management. Credit presentations should include a discussion of the borrower, including how long the company has been in business and what products and/or services it provides. Details about key members of management, including their experience in their industry, is also helpful. This information is sometimes overlooked in a credit presentation, especially for borrowers who have been bank customers for many years, as the lending team knows its borrowers. However, it is important to remember that your regulators and loan reviewers do not have this knowledge, so providing this background information is helpful when reviewing a file.
2. Detailed description of the current loan request. Credit presentations should make it very clear what is being requested. Are borrowers completing an annual review? Requesting a new term loan? Looking to renew an existing credit facility? The request should include all key terms including proposed maturity date, interest rate, amortization, collateral, and guarantor information.
3. Total exposure of relationship. A table showing all credit facilities outstanding to this borrower, as well as any related borrowers, is an important part of the credit presentation. This allows the reader to understand the size of the total relationship.
4. Financial statement analysis. One of the key pieces of a credit presentation is the analysis of the borrower’s financial statements. The balance sheet discussion should explain large changes in accounts, such as cash, accounts receivable, accounts payable, debt, and retained earnings. Balance sheet ratios are also important to gain an understanding of the borrower’s leverage and liquidity. The income statement analysis should explain any meaningful changes in revenues, expenses, and margins. Did the borrower gain/lose any key customers? Has there been a change in profitability? It is crucial to include the explanation for the changes rather than just pointing out the amount of the changes in the financial statements.
5. Cash flow analysis. In most cases, operating cash flows are the primary repayment source for the debt. Credit presentations should include a cash flow analysis that clearly details the borrower’s operating cash flows, as well as its debt outstanding and required debt service. A debt service coverage (DSC) calculation should be completed to determine if operating cash flows are sufficient to meet debt service requirements. Reviewing changes in cash flows, debt service, and/or DSC is helpful to understand the analysis. Breakeven cash flow analyses and interest rate sensitivity analyses are additional items that might be included in the credit presentation.
6. Collateral analysis. Collateral is often the secondary repayment source for the debt. Credit presentations should include detailed analyses that show the potential cash available from the sale of the collateral should the bank need to exercise its right to take possession of it. Separate collateral analyses should be prepared if there are multiple loans that are secured by different collateral. The bank’s standard advance rates should be used to discount the collateral; if an advance rate other than the standard is used, explanation for the variance should be included in the credit presentation.
7. Covenants. If the credit relationship is monitored by covenants, the credit presentation should include a definition of the covenants and their testing frequency. A detailed covenant test should also be included to show whether the borrower has met the requirements. If the borrower has violated a covenant, the credit presentation should detail what actions will be taken to remedy the violation and whether the covenant will be modified.
8. Guarantor information. A discussion of guarantor personal financial statements is important to understand the individual’s liquidity and leverage. A guarantor with meaningful liquidity and limited personal debt is viewed as providing more support for a relationship than a guarantor with minimal liquidity and large amounts of personal debt. A discussion of other contingent liabilities of the guarantor is also important to understand if there are other potential claims to the personal assets of the guarantor.
9. Financial reporting requirements. Credit presentations should detail the financial statement monitoring requirements for the relationship. This should include the type and frequency of financial information required from the borrower and all guarantors.
10. Risk rating. Credit presentations include key information to determine the appropriate risk rating for the relationship. The credit presentation should detail both the current rating and the proposed risk rating. Justification for the proposed risk rating should also be included.
11. Policy exceptions. It is important to recognize any exceptions to the bank’s policy in the credit presentation, as well as justification for the exception. This ensures the approver is aware of the exception and acknowledges it is acceptable to proceed with the current structure.
Do your credit presentations include this information? If yes, you are likely providing sufficient information to your approving officers, allowing them make informed credit decisions. You are also providing your examiners and loan reviewers a useful document to understand the relationship, as well as ensure the credit facilities outstanding were closed as approved. This could result in more efficient exams and fewer questions in the future. For more information, click here.
Kathy Fries is Manager at Enlighten Financial, a specialized consulting firm that focuses on loan review and risk management services to community banks and credit unions. Enlighten Financial has made it our business to shed light on the complex financial landscape, and lead clients in the right direction. We work with financial institutions and other providers to mitigate risk. To talk to Kathy directly, please call: (920) 569-2946.