Business Credit Essentials - Chapter 2

Business Credit Essentials - Chapter 2

• Module Authors: Jasman Tuyon, PhD; Rapheedah Musneh, PhD; Siti Julea Supar; Nurziya Muzzawer
• Faculty: Faculty of Business and Management
• University: Universiti Teknologi MARA, Sabah Branch, Kota Kinabalu Campus
• Course Code: FIN367

Chapter's Outline

• Principles of Lending (9 Principles): More info
• Credit Evaluation Framework: The 5Cs Model; The CAMPARI Model; More info
• Credit Information and Verification: Company documents (credit info); Third Party record/opinions (verification); Warning signals
• Loan and Securities Documentation: Loan Agreement; Loan Agreement with drawdown conditions; Continuing covenants and credit control; Various Covenants; Property Security (with/without title); Other securities; Guarantee and Indemnity

Principles of Lending

• Principle of Risk Taking: Effective risk management identification and mitigation of vulnerable risks; lending covenants, terms, and conditions, and structuring of credit facilities.
• Principle of Prioritizing the Quality of Credit: Pursuing loan growth and account profitability while maintaining loan asset quality; importance of mitigating financial implications of loan impairment. Should extend 50-100 times new credit to compensate for every ringgit of loan losses.
• Principle of Proportionate Stake: Assess owner/shareholder commitment and only debt creditors for fixed returns on the lending risk. A low capital commitment by shareholder/borrower increases loan default risk during economic hardship.
• Principle of Pari-Passu: Lender ensures equal footing in security arrangement and credit exposure with other lenders; avoid being a junior creditor during liquidation.
• Principle of Protection: Negotiating collateral and credit support (e.g., guarantees) in loan structuring; securing adequate cash flow, and ensuring adequate assets to allow lender recovery.
• Principle of Control: Control over loan usage and sources of repayment, proper structuring, and effective lending covenant monitoring.
• Principle of Risk Diversification: Diversifying lending portfolio to mitigate concentration risk on any single borrower, group, industry sector, or market segment.
• Principle of Appropriate Tenure of Financing: Matching loan tenure with borrower's needs to mitigate funding mismatch; control over cash flow to support loan repayment. Longer tenures increase default risk.
• Principle of Purposeful and Productive Lending: Purposeful business lending consistent with the business; lending for productive assets/activities, and meeting loan repayment.

Credit Evaluation Framework

• 5Cs Model: Character; Collateral; Capacity; Condition; Capital.
• CAMPARI Model: Character; Ability to repay; Margin of finance; Purpose; Amount; Repayment terms; Insurance.

Credit Information and Verification

• Company Documents (Credit Information): Crucial for credit assessment; includes business registration, income tax returns, financial statements.
• Third Party Record/Opinions (Verification): Information from credit bureaus (e.g., CCRIS) and other sources, including banker's opinions; valuation reports, risk assessment information, etc.
• Warning Signals: Qualified audit reports, frequent change of offices, court notices of litigation, and non-compliance with regulatory requirements can signal risk. Warning indicators in credit reports like CTOS & CCRIS.

Loan Securities and Documentation

• Loan Agreement: Sets out contractual and legal relationship; includes structure, conditions precedent, drawdowns, covenants, and compliance monitoring.
• Loan Facilities: Full description, amounts, interest rates, repayment and security requirements.
• Conditions Precedent: Conditions for loan availability from the borrower (e.g., board resolutions, disclosure of business arrangements).
• Conditions for Drawdowns: Specific requirements for each drawdown and borrower consent.
• Continuing Covenants (Credit Control): These are crucial for ongoing business continuity and maintain discipline to prevent default in loan repayment.
• Covenants: Financial and general business continuity elements categorized as restrictive and non-restrictive or negative and positive
• Property Security: Freehold and Leasehold land; legal charges as security over properties with/without title; documentation processes for property with title and without title
• Other Securities (Collateral): Fixed Deposits, Stocks & Shares, Unit Trust, Insurance Policy, Assets under Hire Purchase Financing, and Debentures
• Guarantee and Indemnity: Obtaining further credit support; guarantee, indemnity, letter of undertaking from third-party.
• Guarantees: Legally binding contracts ensuring repayment; involve guarantor, lender, and borrower; guarantees must be provided by a third party.
• Enforcement of Guarantees: Processes for enforcing guarantee in case of default (legal proceedings).

This quiz covers the essential principles of lending, credit evaluation frameworks, and documentation involved in loan agreements. Explore models such as the 5Cs and CAMPARI, along with important aspects of credit information and verification. Test your understanding of these crucial concepts in business finance.