WRITING AN EFFECTIVE CREDIT MEMOttsmedia.ttstrain.com/CreditcRE050516.pdf · Purpose of proposed...

5/5/2016

1

WRITING AN EFFECTIVE CREDIT MEMO

Total Training SolutionsBankers Insight Group, LLCJeffery W. JohnsonMay 5, 2016

1Bankers Insight Group, LLC

COURSE OBJECTIVES

To make you a better banker

To understand the importance of good written communication

To improve clarity, conciseness and completeness of written communications

To increase emphasis on planning and organizing

To identify individual strengths and weaknesses


5/5/2016

2

Clear communication is the cornerstone of any financial institution.

It is extremely vital because there is a high degree of “Trust” expected from us

Mistakes in communications can be very costly for financial institutions

Communication

3

What’s Stopping You From Writing That Perfect Memo

There is no such thing as a Perfect Memo

However, if anyone reading your write-up fully understands the facts you are trying to convey with minimum questions, that’s as close to Perfection as you will come.

Bankers Insight Group, LLC 4

5/5/2016

3

Credit Memo Blockers

Lack of Information or outdated information

Receiving too much information and not knowing where to start

Not knowing what to cover

Writer’s BlockBankers Insight Group, LLC 5

It is not only “What” we communicate, it’s “How” we communicate.

Don’t believe me? Check out the next few slides

Communications

Bankers Insight Group6

5/5/2016

4

FRESH VEGETABLES

Would You Buy From This Person?


Flying Lessons

Would You Buy From This Person’s Sign?


5/5/2016

5

ELEVATOR

UP

DOWN

SURGE

PLUNGE


…The company is highly susceptible to an economic downturn and its decreasing financial performance is due in part to the present state of the economy………

Importance of Clear Writing(“Say What You Mean”)

10

5/5/2016

6

STANDARDS OF CARE

What would a reasonable and prudent banker have done under similar circumstances?

The primary purpose of loan documentation is to document your actions as being prudent and proper.


ESSENCE OF THE CREDIT

Your credit files must document a consistently applied approval process. That process should address at a minimum the following points:


5/5/2016

7


Purpose and basis of the credit Primary and secondary source of repayWritten repayment programCollateral valuationsConformity to credit policy Addresses the five C’s of credit Identifies strengths and weaknesses



Justification for exceptions to underwriting

Makes recommendation

Grades credits

Contains information to make decision: Company Financial Statements

Tax Returns

Personal Financial Statements

Applications


5/5/2016

8

CREDIT MEMOS

Primary means of communication within banking industry

Serves three functions: Supports or recommends action

Provides information on the condition and status of a customer relationship

Provides a record of thoughts and actions relative to a customer relationship


Have You Addressed The Basics?

Who Are They?

What Do They Do?

Why Do They Do It?

How Do They Do It?

Who Else Does It?

Can They Make Money?

How Can We Help?

How Do We Get Paid?

16

5/5/2016

9

CREDIT MEMOS

Memos are to be succinct and to the point, but we violate this idea

Readers of credit memos are skilled bankers; therefore, it is not necessary to state the obvious.

Memos should present relevant, material facts and writer’s thoughts and opinions


CREDIT MEMOS

The writer’s opinions should be supported by facts

Remember, anything you write in a memo will become public record if you end up in court with a customer


5/5/2016

10

19

ORGANIZATION

PLANNING

POSITIONING

WAYS TO ORGANIZE

OUTLINING

Bankers Insight Group, LLC

20

PLANNINGQuestions to Consider

1. What is my purpose?1. To inform

2. To persuade

3. To get action

4. To recommend

5. To advise

6. To identify a problem


5/5/2016

11

21


2. Who is my audience?• Key Audience

Senior Credit Officer

Loan Committee

Manager

Colleagues

• Secondary Audience Consider their needs

Use appropriate tone

Avoid industry language


22


3. How can I best convey my message?

• Logical presentation gives you credibility

• Guides the reader in the direction you want them to go

• Keeps your purpose and audience in mind


5/5/2016

12

23

POSITIONING

1. Identify your Position• The main idea of your entire report• All statements, conclusions or recommendations

should support position

2. Establish your major discussion areas• The major points that led you to your position• Note your major discussion areas early in your

presentation

3. Results• Helps writer to focus and the reader to comprehend

the ideas that follow


24

OUTLININGBENEFITS Outline places topics to be covered in an

orderly manner. Benefits include:

Saves time

Improves organization

Allows a step-by-step approach

Allows writer to avoid missing the most important facts


5/5/2016

13

25

PARAGRAPH DEVELOPMENT

1. Name the purposes of a paragraph?• Breaks writing into single ideas• Keeps writing in a uniform and orderly pattern

2. Paragraph Structure• Should have a topic sentence• The topic sentence represents the main idea • Topic sentences are often the 1st sentence

• Each sentence should contribute to para. purpose


26

TRANSITIONS

1. What are Transitions?

• Show the relationships between ideas

• Helps the flow of your ideas: they act as signals for the reader to follow

• Rid your writing of the “choppy” sound


5/5/2016

14

27

Examples

Without Transitions“Profits have been below average for the past three

years. Asset growth has been nearly twice that of its peer group. Net worth has decreased by 20%.”

With Transitions“Profits have been below average for the past three years. During the same period, asset growth has been nearly twice that of its peer group. As a result, net worth has decreased by 20%.”


28

SUMMARIES

Principles of Summaries Should not introduce any new ideas

Not always necessary, unless the situation warrants it. It may be redundant

Summaries are helpful when: Your position is very controversial

Your position may be unpopular with your reader

The report is very long

The structure of the report is very complex


5/5/2016

15

29

WORD USAGE

1. Choose the right words always• Write to express, not to impress

• Avoid stuffy and vague words

2. Avoid using a “Heavy Style” of writing• It is improper for business communication

• Indicates unclear or illogical ideas

• Indicates lack of knowledge by bluffing with complicated and wordy writing


30

WORD USAGE

3. Utilize a “Simple Writing Style”

• The more complex the subject, the more precise and simple the writing

• Understanding words and sentences should require little energy by the reader


5/5/2016

16

31

WORDINESSSay what you need to say with the fewest words possible

Instead of:

At the present time

In the near future

A majority of

A number of

In the amount of

With reference to

First of all

On an annual basis

Why not write:

Now, currently

Soon

Most

Several, many, some

For, of

About

First

annually


32

FORM AND APPEARANCE

Avoid producing a page of solid print. Readers like short, “skim-able” writing. Visual appearance should aid understanding, not hinder it.

Make reports eye catching with headings, bold face, underlining, italics or bullets. This method calls attention to areas that are important.

Paragraphs should average 7-10 lines

Use repetition for emphasis in long reports

Graphics can add variety and professionalism to reports.


5/5/2016

17

Memo Policy

The purpose of a standard Credit Approval Document is to promote a consistent approach towards preparing credit approval presentations.

The Credit Approval Document format is intended to convey to others the lending officer's analysis and understanding of the inherent credit risk and strategies for the management of that risk.


Cornerstones of a Good Loan Portfolio

Soundness, Profitability & Growth


5/5/2016

18

Other Purposes of Memo

Credit approval rationale.

Purpose of proposed credit presentation.

Proposed loan quality rating rationale.

Key risks and structural issues.

Strengths and weaknesses (i.e. cash flow, collateral, guarantor) of the borrower and the credit facilities.

Sources of repayment and plans for monitoring.

Comparison of the proposed credit presentation with approved credit policies, underwriting standards and underwriting guidelines.

Total relationship and relationship strategy, including a risk management strategy for the subject credit exposure.


Purpose

Intended to be a self-contained, stand-alone document which a knowledgeable, experienced lender who is not a specialist in the specific industry being addressed should be able to understand.

Should fully support and explain the credit request without the need for verbal explanation or reference to external documents. All lenders should


5/5/2016

19

Audience

Chain of authority required to approve or concur with the transaction (e.g. Approval Matrix)

Credit examiners, Credit Review Officers, FDIC, State, external auditors, etc.

Other lending personnel who need to brief themselves on the relationship, e.g. as account management responsibilities change

Counsel and others responsible for preparing loan documentation

37

Confidentiality

Credit Approval Documents and quality assessment ratings (QAR) will not be made available to anyone outside (except those identified above) unless subpoenaed by proper court order.

38

5/5/2016

20

Confidentiality

Credit Approval Documents should be written with such third-party review in mind.

Credit Approval Documents generally should not contain legal opinions obtained in connection with the lending relationship.

39

Reflect Your Standard of Excellence

Should reflect the lending officer’s best work.

Based on the data contained in the Credit Approval Document, signers in the approval process are asked to join with the lending officer in being held accountable for putting the bank’s capital at risk


5/5/2016

21

Points of Advice

Question and challenge the data, don't just "report" it.

Be concise. Use salient facts to support conclusions and structure.

Use all available resources.

Create order and understanding out of the "data". Everything written should point toward a conclusion necessary to reach a decision.


Points of Advice

Do not state conclusions without showing the logic that leads from the data to the conclusion. One overused conclusion, which is often totally unsupported, is "The quality of management is excellent".

Be balanced. Be totally honest. "Tell it like it is".

Identify the real issues that make a difference to us.

View everything from the perspective that we are putting BANK capital at risk.

Be reader-friendly. Act as a guide to lead your reader through your data and logic to reach your conclusions. Use charts when needed.

Be consistent.


5/5/2016

22

What Should be in a CM?

Transaction Description

Economic & Competitive Environment

Management

Critical Financial Development / Trends

Evaluation of Repayment Sources / Projections

Collateral Evaluation

Primary Risks in Order of Priority / Mitigators

43

What Should be in a CM?

Covenants Tracking

Plan for Monitoring

Comparison with Policy

Relationship Strategy / Compensation

Strengths & Weaknesses

44

5/5/2016

23

RATIO DEFINITIONS, CALCULATIONS & INTERPRETATIONS In order to write about financial issues

effectively, you must know:

1. What to measure

2. How to measure it

3. What it means

4. How to tell someone


SIX C’S OF CREDIT

CHARACTER

CAPACITY

CAPITAL

COLLATERAL

CONDITIONS

CAN WE?


5/5/2016

24

LLAM-OP-CA-FLOCC

LIQUIDITY

LEVERAGE

ASSET MANAGEMENT

OPERATIONS

CASH FLOW

CHARACTER

CONDITION


LIQUIDITY

Current RatioCurrent Assets or Quick AssetsCurrent Liabilities Current Liabilities

Accounts Receivable TurnoverAccounts Receivable X 365 Days

Sales

Inventory TurnoverCost of Goods Sold X 365 Days

Inventory

Accounts Payable TurnoverCost of Goods Sold X 365 Days

Inventory48Bankers Insight Group, LLC

5/5/2016

25

Net Working InvestmentA/R Turnover (days) 49 $1,280,000+ Inventory Turnover (days) 116 $2,205,000

= Operating Cycle 165 $3,485,000

- A/P & Accrued Expense turnover 27 ($ 506,000)

= Net Working Investment 138 $2,979,000

- Prorated Cash Flow From Oper ($ 265,000)

- Adjusted Working Capital ($2,525,000)

- Bank Line of Credit $ 189,000


LEVERAGE

Leverage refers to the proportion of funds invested in an entity by the creditors in the form of loans and the owners in the form of equity.

Highly leverage firms (those with heavy debt in relation to net worth) are more vulnerable to business downturn than those with lower debt to worth positions.


5/5/2016

26

LEVERAGE

Total Debt Ideal is < 2:1Tangible Net Worth

Total Debt Ideal is < 50%

Total Assets

-


ASSET MANAGEMENT

Asset Management or Efficiency Ratios measure management’s ability to utilize assets to generate revenue or create value (i.e. generate a profit).


5/5/2016

27

Asset Efficiency or Asset Turnover Ratio

Calculation: Total Sales Total Assets

Calculation: Total Sales

Net Fixed Assets

Calculation: Accumulated Depreciation Gross Fixed Assets


ASSET MANAGEMENT

Calculation: Net Fixed Assets*Depreciation Exp.


5/5/2016

28

OPERATION/PERFORMANCE RATIOS

Gross Profit Net Sales

Operating Profit Net Sales

Net ProfitNet Sales

ROE & ROA55Bankers Insight Group, LLC

MARGIN CHANGE ANALYSIS

Measures the financial impact of a margin changing from year to year

Each basis point change in a cost or expense equates to an increase or decrease in profitability

A basis point is the change in the interest rate or yield expressed as 1/100th of one percent


5/5/2016

29


Sales 1,500 1,750

Cost of Sales 900 60% 1,085 62%

Gross Profit 600 40% 665 38%

Operating Exp 525 35% 613 35%

Net Profit 75 5% 52 3%



40.0(38.0) 1,750,000

2.0bp100 = X.02

(35,000)

Company could have made an additional $35,000 if the Gross Profit Margin did not change. Profits should have been $87,000 instead of $52,000


5/5/2016

30

FINANCIAL RATIOS

Interest Coverage Ratio

EBIT Ideal is 2:1

Interest Expense


CASH FLOW / DCR

Traditional Method:

Net Income

+ Depreciation

+ Interest

Available Cash Flow


5/5/2016

31

Adjusted Cash Flow AnalysisNet ProfitPlus: Non-Cash Charges+ Change in Accounts Receivable+ Change in Inventory+ Change in Accounts Payable+ Change in Accrued Expenses

= Cash After Operating Cycle

Minus: Dividends Declared

+ Change in Net Worth

= Cash After Financing Cost

Less: Current Portion of Long-Term Debt

= Cash Available for Other Debt

+ Change in Gross Fixed Assets

= Financing Surplus (Requirement)


*Potential Gross Income (PGI) – Less: Physical Vacancy – Economic (Credit) Loss

Effective Gross Income (EGI)

Less: Operating Expenses

Real Estate Taxes Hazard Insurance Repair/Maintenance (Buildings) Maintenance (Grounds) Depreciation Water/Sewer/Trash Electric (Common) Interest Expense Management Fees Leasing Commissions Reserves for Replacement _______________________________ _______________________________ Total Operating Expenses

Net Operating Income (NOI)


5/5/2016

32

Savannah Fresh Fish Company

Financial Statements

Ratio Analysis Worksheet


LIQUIDITY

Liquidity is deteriorating

Receivables and Inventory are slowing

Payables are slowing


5/5/2016

33

LEVERAGE

Leverage is rising, but still at a comfortable level.

Must watch trend of leverage in the future


ASSET MANAGEMENT

Assets are performing well in producing sales and profits


5/5/2016

34

OPERATIONS

Sales are increasing at a rapid rate

Gross Profit Margin is improving, providing a positive financial impact

Operating Expenses were held steady in spite of rapidly growing sales

Resulting in a higher level of Net Profit67Bankers Insight Group, LLC

TRADITIONAL CASH FLOW

Net Income 115

+ Depreciation 154

Available Cash Flow 269

Annual Debt Service 23

Debt Coverage Ratio 11.7X


5/5/2016

35

Cash Flow “The Right Way”

Net Profit 115+Depreciation 154Available Cash Flow 269

+ Chg. In A/R (311)+ Chg. In Inv. (443)+ Chg. In A/P 234+ Chg. In A/E 95

Cash After Oper. Cycle (156)69Bankers Insight Group, LLC


Cash After Oper. Cycle (156)

- Dividends/Withdrawals ( 19)

Cash After Financing Cost (175)

- Current Portion LTD ( 23)

Cash Avail. For Other Debt (198)


5/5/2016

36


Cash Avail. For Other Debt (198)

- Chg. Gross F/A (220)

Financing Surplus (Shortage) (418)


CASH FLOW

Cash After Operating Cycle

Cash After Financing Cost

Cash Available for Other Debt

Financing Surplus (Requirement)


5/5/2016

37

CASH FLOW IMPACTTurnover In Days

2009 2010 2011

A/R 29.2 .2 29.2 3.7 32.9

INVENTORY 19.6 2.5 17.1 15.8 32.9

ACCTS. PAY. 11.1 2.1 13.2 7.4 20.6


CASH FLOW IMPACT

1 DAYS SALES = $11,025,000365 DAYS

= $30,205

1 DAYS COGS = $8,240,000 365 DAYS

= $22,57574Bankers Insight Group, LLC

5/5/2016

38

CASH FLOW IMPACT

A/R: $30,205 X 3.7 Days = $111,925

INV: $22,575 x 13.3 Days = $300,252

A/P: $22,575 x _9.5 Days = $211,640

Net Cash Flow Impact = $200,537


Samples of Real Estate Write-Ups


5/5/2016

39

SUMMARY & RECOMMENDATION



Thank You!Jeffery Johnson

[email protected]

TTS

Dan Heldmann

[email protected]

www.BankWebinars.com

800-831-0678

Upcoming Webinars

May 5th – All About Escrows

May 9th – Federal Compliance School OnDemand with Live Streaming

May 9th – Are They Really a Bank Prospect?

May 11th – Understanding Commercial Loan Documentation

May 11th – Lending 101

May 12th – Excel Explained: Minimized Spreadsheet Errors

May 12th – BSA for the Frontline

May 23rd – BSA Series: Alert! New CIP Rules on Prepaid Cards

May 24th – Officer Calling: Prospecting, Preparing & Presentation

May 24th – Marketing & Advertising Compliance, including UDAAP Expectations

Upcoming Webinars

May 5th – All About Escrows

May 9th – Federal Compliance School OnDemand with Live Streaming

May 9th – Are They Really a Bank Prospect?

May 11th – Understanding Commercial Loan Documentation

May 11th – Lending 101

May 12th – Excel Explained: Minimized Spreadsheet Errors

May 12th – BSA for the Frontline

May 23rd – BSA Series: Alert! New CIP Rules on Prepaid Cards

May 24th – Officer Calling: Prospecting, Preparing & Presentation

May 24th – Marketing & Advertising Compliance, including UDAAP Expectations

WRITING AN EFFECTIVE CREDIT MEMOttsmedia.ttstrain.com/CreditcRE050516.pdf · Purpose of proposed...

Documents

Transcript of WRITING AN EFFECTIVE CREDIT MEMOttsmedia.ttstrain.com/CreditcRE050516.pdf · Purpose of proposed...